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Executives

Chris Arnold – Communications Director

Steve Ells – Chairman of the Board & Co-Chief Executive Officer

Montgomery F. Moran – Co-Chief Executive Officer & Director

John R. Hartung – Chief Financial Officer

Analysts

David E. Tarantino – Robert W. Baird & Co.

Jason West – Deutsche Bank

Larry Miller – RBC Capital Markets

Matthew DiFrisco – Oppenheimer & Co.

Jeff Farmer – Jefferies & Company, Inc.

Jeff Omohundro – Wachovia Capital Markets

Sharon M. Zackfia – William Blair & Company

Robert Wyler – Piper Jaffray

Tom Forte – Telsey Advisory Group

Paul Westra – Cowen & Company

Greg Ruedy – Stephens, Inc.

Steven Rees – JP Morgan

Chipotle Mexican Grill, Inc. (CMG) Q2 2009 Earnings Call July 22, 2009 5:00 PM ET

Operator

Welcome to the Chipotle second quarter 2009 earnings conference call. All participants are now in a listen only mode. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce Chipotle’s Communications Director Mr. Chris Arnold.

Chris Arnold

By now you should have access to our earnings announcement released this afternoon for our second quarter 2009. It may also be found on our website at www.Chipotle.com in the investor relations section. Before we begin our presentation I would remind everyone that parts of our discussion today will include forward-looking statements within the meaning of the securities laws.

These forward-looking statements will include projections of restaurant comp sales trends, the number of restaurants we intend to open, the timing and amount of our planned share repurchases and expectations regarding our new advertising campaign as well as 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 annual report on Form 10K for 2008 that is updated in our subsequent 10Qs for a discussion of the risks that could impact our future operating results and financial condition. I want to remind everyone that we have adopted a self imposed quiet period restricting communications with investors during specific 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 third quarter it will begin September 1st and continue until our third quarter release in October.

On the call with us today are Steve Ells, our Founder, Chairman and Co-Chief Executive Officer; Monte Moran, Co-Chief Executive Officer; and Jack Hartung, Chief Financial Officer. After their comments we will open the call for questions. Before beginning, I should note that our prepare remarks are a little shorter than usual, we’ve been pressed for time during the Q&A portion on the last couple of calls and wanted to be sure to leave a few more minutes for that.

With that out of the way, I’ll turn the call over to Steve.

Steve Ells

We are pleased with our second quarter performance particularly in light of an overall operating environment that remains challenging. For the quarter we delivered a 1.7% comp and saw revenues increase 14.1% from a year ago. This brought our revenues to $388.8 million for the period and led to diluted earnings per share of $1.10, a 48.6% increase from the second quarter of 2008.

Our ability to grow our business in this difficult economy is the direct result of our disciplined and focused business model which emphasizes doing just a few things but doing them better than anyone else and our ongoing review of current practices with an eye to making them better. Most recently, we have turned our efforts in this regard towards our marketing which we do not think has kept pace with developments we have made with our food and people cultures but I firmly believe we are headed in the right direction.

Since the first of the year, we hired our first ever chief marketing officer and selected a new advertising agency. More recently, we launched a new advertising campaign we call my Chipotle which was designed to harness the power of our loyal customers to create ads for us and demonstrate great variety by highlighting actual food combinations that our customers chose. So far, we have received thousands of submissions from our customers at www.MyChipotle.com and the website that is the cornerstone of this campaign.

While we have been encouraged by that, it is clear that most of the spots our customers have created, while they’re interesting and amusing, are not strategically aligned with the story we want to be telling about Chipotle. Our own research has shown that most of our customers are not aware of the length Chipotle goes to bring them high quality, affordable, healthful foods that come from more sustainable sources. What we have seen through this campaign reinforces that. As a result, we believe we will be best served if our marketing takes that direction.

Just recently, ABC’s Nightline did a segment that explained in great length the effort that we take to source the ingredients that we use to make our food. That story prompted thousands of phone calls and emails from customers who were overwhelmingly supportive of our efforts and the progress that we have made. They explained that our mission is relevant and important to them and that tells us that many of our customers are receptive to this message and that it is time to incorporate that in to our broader marketing.

The my Chipotle campaign will continue but only as an online program which is where it has drawn the most interest and where the ads developed by our customers can be easily shared in viral ways. But, we are redirecting our overall advertising to focus on our food philosophy and our efforts to source the very best ingredients because, that is what really differentiates Chipotle and increasingly, it is resonating with our customers. This shift in direction will change many aspects of our marketing program.

Most notably there will be a stronger emphasis on educating the half a million customers who eat at Chipotle every day. Using communications in our restaurants, online, in social media and through other avenues, we will work harder to help our customers better understand these important differences. Because word of mouth has always been such an important component in building our brands, we truly believe that better educated customers will in turn help us with this effort moving forward.

I think it’s important to remember that our advertising, while certainly the most visible part of our marketing mix to most people is just one component of our overall marketing program and we are continuing to make significant progress in other areas of our marketing including local store marketing, direct mail and public relations. The success of these programs is evident in a current promotion we are doing supporting the documentary film Food, Inc. that has us sponsoring free screenings of the film in 32 cities, promoting the movie in our restaurant and online and affords us a bonus feature on the DVD release of the film later this year.

So far, this promotion has generated significant numbers of comments and overwhelmingly positive feedback just like the Nightline piece did. We believe that programs like this continue to help us reach and inform our customers in a very meaningful way. Redirecting our advertising to better support this direction will enhance the effectiveness of our marketing as a whole.

Lastly, I’d like to take just a minute to update you on the status of the menu test we have been running in Denver. For now, we plan to leave that test which includes some feature items, a new soup, items with smaller portions and smaller prices and a kids menu in place in all of our Denver restaurants as we are seeing some encouraging signs from this. Among the high points are that we have held our check average in spite of the opportunity for our customers to trade down in price and we have seen enough demand for our kids menu that we plan to test that part of the menu in all of our Salt Lake City restaurants as well. We will certainly keep you apprised of other developments on the menu as tests warrant.

I’ll now turn the call over to Monte.

Montgomery F. Moran

Since our last earnings call a few months ago I have continued to spend a great deal of my time visiting restaurants meeting more and more top performing current restaurant managers as well as meeting top performing crew who will undoubtedly be our future managers and restaurateurs. I continue to be impressed with how our managers are constantly raising the bar in terms of identifying and developing talented crew, removing low performers from their ranks and treating each customer to the best Chipotle dining experience possible.

Our entire company has been committed to this effort to develop a special people culture for at least a few years now, a culture which appeals to and empowers top performers and a people culture which matches the special food culture which has been a part of Chipotle since the first restaurant opened in Denver 16 years ago. While most companies will talk about how important their people are, our people culture has allowed Chipotle to redefine what’s possible for a restaurant growth company.

For example, while most restaurant growth companies have historically relied heavily on franchising to fuel their growth, we’ve been able to grow by offering fulfilling career opportunities to our own employees hired as crew without giving away our superior operating returns by franchising. While growth companies typically find it difficult to run consistent operations as they grow larger, as we approach 900 company owned restaurants our restaurants operate better than ever and our positive web comments about customer service, which have always been high continue to increase.

Finally, while our unit economic model has always been very strong, with very efficient labor staffing, our top performing managers have redefined what an efficient labor model can achieve and all of our restaurant managers are following that lead. This has resulted in significant labor leverage that even we did not think was possible just a few years ago when we first introduced our national labor metrics. In fact, even during recent earnings calls and analysts meetings I had suggested that we would not be able to continue to find more than small amounts of additional labor leverage but, our teams in the field proved me wrong.

We realized a 140 basis point improvement on labor cost during the quarter which contributed to our achievement of the highest restaurant level margin we have ever achieved. From talking to our managers and other leaders in our restaurants I am optimistic that about two thirds of that leverage is sustainable going forward. I wouldn’t be able to say that if I hadn’t been in so many restaurants over the past several months to see that our teams are preparing and cooking great tasting food, providing extraordinary customer service and running clean and organized restaurants with this more efficient approach to staffing. In essence, what we’re seeing is the powerful result a restaurant team can accomplish when all of the team members have high performing potential and all the low performers have been removed from the team.

We continue to make progress in empowering our best performers by placing them in to positions where they can have the greatest impact. You can see this in the growing number of managers now in our restaurateur ranks, many of whom continue to run their own great restaurant while mentoring a nearby restaurant or even two or more. Right now we have 137 restaurateurs and these restaurateurs are mentoring another 76 managers so more than 200 of our restaurants are feeling the direct impact of the leadership of these elite restaurateurs. Since every one of our remaining managers aspire to be a restaurateur one day, our 137 restaurateurs continue to set the example for all of our managers to follow.

Chipotle is a special brand with a compelling vision, a strong food culture and a strong economic model. With our strong and growing people culture we will continue to redefine what a growth restaurant company can accomplish. I’ll now turn the call over to Jack.

John R. Hartung

The strength of our model continues to produce superior restaurant level margins despite the current economic conditions. Our restaurant managers and crew remain committed to preserving this model through their focus on excellent customer service and working hard to earn each and every customer visit. Our results for the quarter illustrates that our culture of top performers can elevated our financial performance and deliver superior returns on invested capital.

Our revenue for the second quarter increased 14.1% to $388.8 million from $340.8 million last year. Revenue growth was driven by new restaurants not in the comp base and a 1.7% increase in comps. The comp growth was driven by a little more than a 6.5% effective menu price increase partially offset by a negative traffic of around 3.5%. The average check was up a little over 5% from last year, slightly less than the full menu price increase. While sales and transaction trends remain soft due to the effects of the economy, they generally seem to be stabilizing at about this level. So, assuming no further deterioration in the economic climate we continue to expect comps for the year in the low single digit range.

EPS for the quarter was $1.10, up $0.36 or 49% from last year. Restaurant level margins were 26%, up 360 basis points from last year. The increase in the margin was primarily the result of menu price increases, labor efficiencies and lower marketing expense in the quarter. Food, beverage and packaging costs for the quarter decreased 140 basis points from last year to 30.9%. The decrease was mainly driven by the impact of the menu price increase offset by the higher cost of chicken and rice from the second quarter of 2008. Beef, pork and cheese saw modest declines compared to last year.

Labor improved 140 basis points from the second quarter of 2008 to 24.5%. The menu price increase offset the negative effects of inflation and deleveraging from decline in transactions allowing labor efficiencies from more effective staffing to drive the 140 basis points of net leverage within the quarter. As we continue to focus on building a culture of only high performers, we believe we can continue to serve great tasting food, offer superior service with the fewer hours needed in the restaurants.

Occupancy costs increased 30 basis points to 7.2% of revenue in the second quarter and as we discussed on previous calls, the increase is the direct result of opening more restaurants in more expensive densely populated areas like Boston, New York, Philly and Florida. Other operating costs decreased 138 basis points from last year to 11.3% of revenue. The decrease is primarily the result of the timing of marketing expenditures and lower promotional costs. Marketing costs were 1.9% of sales during the quarter compared to 2.5% last year. We continue to expect our marketing costs to average about 1.8% of sales overall for the full year. Year-to-date we spent 1.5% of sales on marketing so expect marketing in the third and fourth quarter to be higher.

G&A increased 50 basis points from last year to 6.6% of sales and the increase as a percentage of sales is the result of lower performance based bonus accruals in 2008 which includes a reversal from first quarter of 2008 and that was partially offset by the menu price increases. Preopening costs decreased 60 basis points from last year to .4% of sales and this line was driven by fewer openings so far in 2009 compared to last year. We opened 24 new restaurants in the second quarter of this year compared to 49 restaurants last year. That brings our total restaurant count to 886 restaurants as of June 30th. Despite the timing differences in the first half of this year, we expect the 2009 preopening expenses to be similar to 2008.

We continue to expect to open 120 to 130 new restaurants with about two thirds of the remaining openings scheduled to open in the fourth quarter. While we’re confident with the number of openings scheduled, there is some timing risks. Some restaurants could conceivably slip in to 2010. Our new restaurants continue to open at volumes around $1.35 to $1.4 million as they have for the past few years now with two thirds of our restaurants opening in mature or proven markets.

Our tax rate for the quarter was 38.4% and we expect our tax rate to be 38.4% for the full year. During the quarter we continued our $100 million stock repurchase and our nearly complete. As of today we have invested nearly $95 million to purchase over 1.7 million shares of our class B stock at an average price of just under $54 a share. Even with the completion of the buyback nearing, we still have over $200 million of cash on the balance sheet and we’re not relying on outside capital in any way to fund our growth.

We continue to work on the possibility of collapsing the A and B shares, working closely with our attorneys and McDonalds to identify and try to resolve potential issues and risk with the possible collapse. As we discussed on our last call, our tax council has prepared a draft opinion letter as required by our separation agreement with McDonalds and we believe we have come to an agreement with McDonalds on most of the issues regarding the opinion that we’ve identified so far. However, this is a complicated area and the potential exposure is significant so we need to caution you that we are still working with McDonalds to formulate and support an opinion that would be acceptable. We’ll continue to keep you updated as the matter progresses.

Thanks for your time today and now we’d be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David E. Tarantino – Robert W. Baird & Co.

David E. Tarantino – Robert W. Baird & Co.

Jack, a clarification question first on the comps, with the traffic figure you mentioned down 3.5, did that include a drag from the Easter shift and if so could you just quantify what the traffic was including the Easter shift.

John R. Hartung

It did, we lost a day in the quarter, we had one fewer day than last year and we figure that day cost us roughly about 1%. There were really David three things that occurred during the quarter that are factored in the 1.7%. The other thing is we did lose about 2.5% in menu pricing so we dropped down in menu price affect during the quarter. The other thing is we’re going up against softer comparisons compared to last year so all those three things kind of weighed together to net to the 1.7%.

David E. Tarantino – Robert W. Baird & Co.

On an underlying basis if you exclude the Easter shift then traffic improved by about 200 basis points from Q1 if I’m reading that correct.

John R. Hartung

That’s right.

David E. Tarantino – Robert W. Baird & Co.

Would you chalk that up to easier comparisons or was it some of the initiatives you have in place that you think moved the needle.

John R. Hartung

Just to clarify David, we were 4.5% negative in the first quarter, we’re 3.5% in the second quarter and we did lose a day so if you adjust for the day then effectively we’re closer to 2.5% negative traffic. It was really entirely related to comparing to easier comparisons last year.

David E. Tarantino – Robert W. Baird & Co.

Is there any reason to believe as you move out in to the second half and the comparisons ease further why you might not see the traffic continue to improve on a year-over-year basis?

John R. Hartung

I want to be really cautious about that. We do have easier comparisons in the third quarter, we have tougher comparisons in the fourth quarter because we lose basically all of the price increase right now, by the end of the year we lose all of it. We’re not seeing signs, credible signs that consumer confidence is improving. We know unemployment is expected to get worse and so it seems like David things are at best moving kind of sideways right now from a trend standpoint. So, I would hope the easier comparisons would allow us to have respectable comps but we’re being really, really cautious. We’re just not seeing positive signs from the consumer confidence side.

David E. Tarantino – Robert W. Baird & Co.

One last one for Monte, on the labor leverage what did you mean by you’d be able to retain two thirds of that leverage? Does that mean you expect to get more like 90 basis points in the second half of the year? Could you clarify what you meant by that comment?

Montgomery F. Moran

Yes, we had a 140 basis point improvement. Last year during the same quarter we had some labor inefficiencies which we benefitted from in the comparison this quarter so we believe that 100 basis points or so of that leverage is something that’s sustainable throughout the rest of the year.

Operator

Your next question comes from Jason West – Deutsche Bank.

Jason West – Deutsche Bank

I was wondering if you could talk a bit about the other operating line, it looks like you had some nice leverage there, the marketing helped a bit but even outside of that it was still I think about 70 basis points of leverage. Just sort of talk about the sustainability of that and what drove that?

John R. Hartung

The other thing that we benefitted from was lower promo costs. That was about another 40 basis points or so. I’m not sure whether we’ll see the same kind of leverage throughout the rest of the year. I think we’ll see some leverage in promo but as we continue to formulate our marketing and our local store marketing approach throughout the rest of the year and how we’re going to get this message, this food with integrity message and how we source our food, we’re going to use the combination of media, of local store marketing, of PR and so it’s possible that our promo may bounce up later in the year.

The other things that are in this line are things like utilities. That will depend on energy costs and so if energy costs remain tame throughout the rest of the year then we should continue some of that leverage. So, we should continue to see some leverage other than the marketing reversal but I don’t know that we’ll be able to keep all of the remaining leverage that you’re talking about here.

Jason West – Deutsche Bank

Then just big picture, you guys touched on the market program a bit and some of the feedback you’ve gotten from consumers and the direction that you’re going to go, has anything from what you guys have seen in the first six months of the year changed your view in terms of what you were thinking you were going to do from a marketing standpoint for the full year either in terms of the media mix or the messaging? The same question with regard to kind of your outlook on opening new stores, now you guys are saying pretty comfortable with 120 to 130 and should we think about a similar kind of number for next year?

Steve Ells

Well, in terms of the marketing yes we’ve moved directions in terms of the way we’re promoting my Chipotle. My Chipotle now is moving to being promoted exclusively online, it’s a very efficient way to do that. The outdoor, out of home and print advertising in our nine major markets is going to be focused on a program that we call internally tastes good is good and it’s our belief that customers are very interested now in our message about better quality food makes for better tasting food.

We see this evidence from our overwhelmingly positive feedback on our Nightline spot which explains in detail how we source more sustainably rated food and our food with integrity philosophy and how its been around at Chipotle for some 10 years and how it drives our thinking about how we source food. We’re very excited that customers are receptive to this message and the tastes good is good campaign is something that we think will target that specifically.

John R. Hartung

Jason, on the new store openings, we’re still building inventory for 2010. In fact, we basically spend virtually all of 2009 building our inventory for 2010 so we’re just a little bit more than half way through. We’ll give a 2010 opening range with our release in October but I would tell you so far it feels like, based on the inventory building we’re doing so far, it will be a similar number next. I can’t tell you if it will be slightly lower, slightly more but right now it seems like it’s similar.

What’s happening though is there’s a shift in the mix where we’re finding far, far, far fewer new developments, new spaces to go into and we’re having to make up for that by going in to existing spaces. It use to be a couple of years ago more than 60% of all of our openings would be in brand new developer spaces and now it’s looking like based on the inventory building we’re doing so far for 2010 that number will likely fall below 50% and it might fall well below 50%. But we’re so far seemingly being able to make up for that by going in to existing spaces, spaces that someone else had occupied and is now vacating. But, we’ll give a better update, a more current update on 2010 with our October release.

Operator

Your next question comes from Larry Miller – RBC Capital Markets.

Larry Miller – RBC Capital Markets

Just a couple of quick follow ups just to clarify some things you said, when you said moving sideways Jack in terms of traffic does that mean we should interpret to mean that July is kind of in that 2% to 3% down range?

John R. Hartung

Well what I would say is we still think that the overall comp for the year, the guidance that we’ve been giving really all year, the low single digit still feels right. We’re 2.2 in the first quarter 1.7 in the second quarter, easier comparisons in the third, tougher comparisons in the fourth as we lose the menu price increase that we took last year. Overall, it still feels like we’re going to settle in that low single digit range.

I mainly wanted to say we don’t see any real signs that the trends are really bouncing up. I’m still looking for that consumer confidence to kick in and we’re just not seeing that. So, if we stay sideways for a while, we stay with the guidance that we’ve been giving since the beginning of the year, we’ve got what we think are very strong margins, a very strong unit economic model and so going sideways until the consumer recovers we think we can do that for quite some time and hopefully soon, hopefully by the end of the year or maybe even sooner that the consumer will recovery and we’ll see sideways move to an upward direction.

Larry Miller – RBC Capital Markets

Just on the restaurant margin outlook specifically for the second half because there’s so many moving pieces it would be helpful to give – and you just had such a phenomenal first half, just a few on where that operating expense might be where the overall restaurant margin might be and how the food line might look because if I’m right, or maybe what happens with the rate, because you’ve been running around 31% as you roll off some pricing, should we expect that to go up then? Or, how should we think about some of these?

John R. Hartung

Let me tell you about the pieces as we move forward and what to expect. Listen, we’re really pleased with our margins, I mean these are the highest margins that we’ve ever had during this period of time and yes, we’re benefitting from the menu price increase but we’re also benefitting from just a very disciplined approach to managing the business but the way to think about it going forward I’m hoping Larry that we can keep our food in this same kind of range that we’ve seen in the first two quarters, right around 31%.

We’ve been talking about seeing slight inflation, low single digit inflation but the further we get in the year, the less likely that inflation is to hit. So, we’re kind of hoping that we’ll be able to hold at that 31% and if a little bit of inflation creeps in we might see that number tick up a little bit by the fourth quarter but still very close to that 31% range. I would also encourage you to take in to account seasonality. Second quarter is historically always our highest margin quarter, it’s our highest from an average daily sales standpoint and so we always get a lot of leverage so you should expect to see a normal fall of in the margin as you move to the third quarter which is our second best quarter from a margin standpoint. Then the fourth quarter you should expect to see a seasonal fall off. Again, you can go back to our few prior years and see that those margins do fall of seasonally.

The other thing that I would encourage you to look at is we have a significant number of openings in the fourth quarter. We have 49 new store and that’s going to do two things, you’re going to see a lot more preopening expense in the fourth quarter, you’re also going to see a drag on the P&L. When we only open up 24 or 25 restaurants during a quarter that has only a slight drag on our margins and when we hit the fourth quarter you’ve got 49 restaurants that are going to have only a month or two or so of sales. The P&L in that month or so are very rough, they’re very, very sloppy if you will.

We have a lot of people that we’ve hired to train, the food we don’t have the food dialed in and we really don’t focus as much as running a tight P&L during those first few months as much as we focus on making sure that we treat each and every customer, especially since they might be brand new customers, to the best Chipotle experience possible so that will be a drag as well. Then finally, the marketing, keeping in mind we’ve only spent 1.5% so far this year, we’re going to spend about 1.8% for the full year so we will spend more in the third and fourth quarters. I think if you take those things in to account and kind of layer those in to the margins we’ve seen so far this year you’ll get a good idea where we might end up.

Larry Miller – RBC Capital Markets

The last thing for me and then I’ll get off the line, can you remind us, I know you talked about this in the past but why it is average restaurant sales are trending down although you have the new store volumes at that same rate?

John R. Hartung

Larry, that’s a function of when you have a very comp which is in this 2% range, that has a slight upward tick on the existing base but that’s more than offset by the fact that even though our new stores are holding at opening up $1.350 to $1.4 million, when you layer in 100 or 120 which is how many we layer in each year, when you layer them in at $1.350 to $1.4 million you’re existing average TTM is in say the $1.750 to $1.760 million, it’s just naturally the law of averages is going to bring that number down. The only way to keep that number up is to have a comp that is higher than 2% that will offset the layering effect of having these $1.350 to $1.4 million added to our comp base.

Operator

Your next question comes from Matthew DiFrisco – Oppenheimer & Co.

Matthew DiFrisco – Oppenheimer & Co.

I have a follow up question a little bit on that new development and how that’s skewing, what is your experience as far as the overall investment cost or the site opening volumes? Would you anticipate that being traffic already there so you’re not necessarily see the follow on comp but maybe opening up at bigger volumes? Then also am I presuming correctly if given it’s a shell you’re assuming, in the current economic environment you’re probably coming in at a lower investment cost as well?

John R. Hartung

Let me talk about the cost first, first of all we expect for the full year that our openings will average right around $900,000 just like they have for the fifth year running that we’ve been right around $900,000. Unfortunately, going in to existing space actually costs us more. There’s usually nothing, very little or nothing, in the existing space that we would end up keeping. None of it really contributes to the trade dress that we’re looking for, none of it really matches the functionality that we’re looking for with the kitchen that we want to build out and the flow that we want to build for our customers.

So, there’s actually more work and more money spent to go in to an existing space then gut it, rip it out and you have to replace a lot of the functionality, a lot of the electrical and plumping and things like that. So, unfortunately it actually costs more to go in to the existing spaces, not less. It’s always easier to go in to a very clean brand new space. Having said that, we still think we’ll average right around $900,000.

In terms of sales, I would continue to expect that we’ll open up at $1.350 to $1.4 million kind of range. We’re still looking for the same type of trade areas that we’ve had in the past. The difference is rather than looking at going in to a brand new development we’re going in to an existing development. We really haven’t fundamentally changed the type of trade area that we’re looking at so I wouldn’t expect to see a change in trend with the new store sales.

Matthew DiFrisco – Oppenheimer & Co.

Then also just looking at how we should expect some of the new development to affect some of the line items especially say in the fourth quarter if you’re going to open up 50 to 55 stores or so, would you presumably expect greater labor deleverage in that quarter in particular because of the resumption of a more meaningful year-over-year incremental growth? And also, what that might mean to some of the efficiency gains you’ve already reflected in cost of goods sold, occupancy and other things and other operating expense as far as incorporating those 50 plus stores? I really can’t go back and find a quarter we’re you’ve opened that many before so is there a little bit of concern prepping for that type of a large opening in such a short period of time?

John R. Hartung

Well, we opened I think it was 49 or 48 in the second quarter of last year so we have done this before. It will have a drag on the P&L and to be honest Matt, I don’t feel comfortable predicting what impact that would have. I would just caution you to be conservative in the fourth quarter as you’re rolling forward from the second quarter and factoring the things in that I mentioned before. I would take in to account that another factor is our margins are going to tick down a little bit but I just don’t feel comfortable giving you an amount because we’re adding 49 stores and that will be a drag on the P&L.

Matthew DiFrisco – Oppenheimer & Co.

Then also looking at the reasons for some of the delays is that something that you’re now just coping with by going further out in the pipeline or starting the pipeline earlier on? Or, are you sort of beholding to some of the developers just missing their promises, their initial opening dates and your co-tenants sort of dragging their feet on opening up around you as well? What’s the main cause for the delays?

John R. Hartung

We’re beholden to the developer. I mean, we’re ready, our time lines are very efficient but they’re just being turned over to us later. It’s just delayed because of delays in financing or delays in filling up the space with tenants or you name it. But, as soon as we get the space we can move fast and we have a very predictable time line so it’s all a function of when we get the site turned over to us.

Operator

Your next question comes from Jeff Farmer – Jefferies & Company, Inc.

Jeff Farmer – Jefferies & Company, Inc.

Jack, I might have missed this but did you highlight your preliminary pricing plans for 2010? Did you give us any color on what you might do there?

John R. Hartung

No, we don’t have any plans now Jeff to do anything from a pricing standpoint. As long as commodity inflation remains tame, our margins are in great shape. We’d rather sit back and be patient as it relates to any menu price increase.

Jeff Farmer – Jefferies & Company, Inc.

Then just as related to your commodities, just to help us a little bit in terms of direction potentially next year, when we’re looking at chicken, beef, pork costs for you guys should we be tracking the spot prices or is it more useful to track things like corn and soy? I guess historically my understanding was this is essentially a cost plus situation for you guys? What’s the best way to monitor your commodity prices on the protein side moving forward?

John R. Hartung

Well, there’s nothing perfect Jeff I mean you can check the spot market, I would look to corn because clearly if corn goes up that’s going to cause an impact on the cost of our protein. You also have to look at the strength of the dollar because whenever the dollar either strengthens or weakens you have the opposite effect on commodities so that would have an effect as well. Generally Jeff, I think over time when spot prices go up or down, generally our naturally raised prices are going to move in that same direction but not always at the same rate and not always at the exact same time.

There are some irregularities like we’ve seen with chicken so far that our chicken prices have not really dropped nearly as much as commodity chicken mainly because the economics of naturally raised chicken are tougher because there’s lesser demand for the premium priced naturally raised chicken breasts. So, that is a good example of something that we’re not seeing the same effects on what we buy versus the commodity markets. I think generally over time you can look at the spot markets, look at the price of corn but there are always going to be these imperfections. There’s nothing really perfect that I can point you to, to tell you to track it would be a perfect guide for you.

Jeff Farmer – Jefferies & Company, Inc.

Final question, I realize you probably don’t want to provide too much color on this but you’re tracking at 31% on the COGs line this year, is that a sustainable number moving forward? I know there are a lot of moving pieces there and you probably don’t want to give too much detail but is that realistic to think that you could achieve that two years in a row?

John R. Hartung

Well, it depends on commodity and it depends on what, if anything, we want to do with menu prices if there is inflation. But, I’ll tell you Jeff, our model works at 31% and it works at 32% really well also. The vast majority of our growth going forward is going to be by opening new stores. We still think we can open up thousands of new restaurants and as long as we make sure that our unit economics for the new stores that we open up can generate superior returns, our model works at either 31% or 32%. Certainly, we prefer to stay at 31% but we can afford for that to slip as well.

Jeff Farmer – Jefferies & Company, Inc.

Just a final question, as it relates to pricing power, do you feel that you have that if you needed it, if you need to take another two, three, four points next year, do you think that your customers would push back on that?

John R. Hartung

I think Jeff we’ve got as much, if not more, pricing power than anybody out there. But, I would say we spent a good part of the pricing power that we built up over the years in the fourth quarter last year so I think we’re going to be patient. I think we’d rather let some of the others who’s margins aren’t quite as high as ours, let them dip their toe in the water, let’s see what happens, what kind of customer response they get and then we can be patient in terms of whether we want to increase price or not.

I think generally though, yes we have pricing power. Our customers are very, very loyal and what we found is we’re not losing customers. They may not come as often because they’re tightening their budget or they may cut back on buying a drink but they’re still coming in for their burrito. We still think we offer, and our research says we offer a compelling value to our customers and so we still think we have pricing power.

Operator

Your next question comes from Jeff Omohundro – Wachovia Capital Markets.

Jeff Omohundro – Wachovia Capital Markets

Just wondering if you would elaborate a bit more on the significant food costs improvement? Just how much was simply related to the positive leveraging related to the pricing versus operational improvements perhaps in the units, perhaps in areas such as waste management or portion control? Just maybe a little bit more color on the food costs.

John R. Hartung

Most of it was the menu price. I would say second is the relaxed commodity prices and we’ve done a better job in term of food controls but I would say that would be the minor piece of the improvement.

Operator

Your next question comes from Sharon M. Zackfia – William Blair & Company.

Sharon M. Zackfia – William Blair & Company

Jack, it was good to hear the update on the cost to build out the new restaurants. I think though Steve was going to take a look at the restaurant design and maybe streamline some things or take some costs out or make some changes there and I’m not sure if that’s been a focus yet in the first half of the year or where you are on that?

Steve Ells

It has been a focus and we have been working on that. It’s too early to report any numbers though. But, certainly with the new trade dress that we’re going to be introducing, the new architectural features, that has all be done with an eye towards more efficient installations, smaller footprints, things that are easier to assemble with the goal of making us more efficient and hopefully reducing the price. But, you have to realize it takes a long time to get these in the pipeline, design them, build them and see how much they costs. But, for sure that’s something we’re working towards. Additionally, we’re working towards more efficient kitchens that have a smaller footprint and therefore should be less to construct. But, these are just early designs we have in mind and nothing has been completely built out yet.

Sharon M. Zackfia – William Blair & Company

Do you think we’ll start to see some of those built out by 2010? What’s the kind of time line you have in mind?

Steve Ells

Absolutely, we will definitely see construction finished on a few of these in early 2010.

Sharon M. Zackfia – William Blair & Company

I was asking about the new kind of architectural details that you’re looking at and the footprint and the efficiencies, does that change kind of the density of the markets you can go in to? Does it broaden the bandwidth, does it change the kind of sites that you’ll look at going forward? Just trying to get an idea of how this might change –

John R. Hartung

It’s a great question Sharon. It depends on how successful we are. If we’re really successful and we can fundamentally change our investment costs, so our average right now is $900,000, so for example if we can find some real breakthroughs and I’m not saying that we will but we certainly would like to find some real breakthroughs and if we can for example, lower our investment costs to $500,000, $600,00 as an example, that would open up lots of opportunities for us to go in to markets that today we might shy away from because we’re not sure that the sales would support that. And, it would allow us to go in to some smaller towns that maybe right now we say the demographics wouldn’t support that.

So yes, we would certainly welcome a breakthrough like that because it fundamentally would change our opportunity to grow, it would fundamentally change the competitive landscape as well. We can compete with some other burrito chains that really survive and sometimes thrive at lower volumes that we tend to not like to go in to. So yes, it could have a dramatic effect on our strategy going forward.

Operator

Your next question comes from Robert Wyler – Piper Jaffray.

Robert Wyler – Piper Jaffray

First question, I was just wondering if you can provide just a little bit more color on the same store sales trend throughout the quarter? Just mainly it seems like we saw a blip down in May and June for most concepts and we were just wondering if you guys saw the same sort of thing on the same store sales front?

John R. Hartung

I wouldn’t say that. Keep in mind when you look at our weekly and our monthly sales you’ve got to factor out the fact that we loss a day in April, you’ve got to factor out in early May that we loss 2.5% in pricing and then you have to factor out the fact that we were going against in our case starting to see softer comparisons throughout the quarter. I think when you try to factor all that out it was pretty steady throughout the quarter, there wasn’t any kind of significant weakening. I would say it at best went sideways, there might have been a slight weakening but I wouldn’t say anything too significant.

Robert Wyler – Piper Jaffray

Then so far in to July that’s still the case it’s still pretty steady across the board?

John R. Hartung

Generally yes, generally it’s been at best a sideways type trend line. Hopefully, it will get no worse than sideways but we’ll see how the rest of the quarter unfolds.

Robert Wyler – Piper Jaffray

Then finally on the commodities front, going back to that a little bit, how much of the organic or naturally raised chicken market does Chipotle account for? I’m just trying to get a feel for that.

Steve Ells

I really don’t know the answer to that question, it’s a very significant portion and it’s enough that it moves a lot of suppliers to produce a lot more chicken for us but I couldn’t give you a number on that.

Robert Wyler – Piper Jaffray

That would be the same for beef and pork, those markets as well?

Steve Ells

Yes, yes it would be. We would account for less of the pork market for sure but, it’s really hard to say what the percentage would be.

Robert Wyler – Piper Jaffray

Then finally, did you guys see any regional changes from a same store sales perspective? Anything even the west coast or anything like that or the southeast particularly if you saw any improvement or actually if any of those feel off during the quarter?

John R. Hartung

I would say generally its similar to comments we’ve made either a quarter or two quarter ago that generally we’ve seen strength in the coast, in the west coast and looking at it from a transactions standpoint on the west coast and the northeast and the southeast we’ve seen relative strength in those markets and then we’ve seen relative softer results from a transaction standpoint in what I would call middle America and that would be the Midwest through the Rocky Mountains.

I wouldn’t call them dramatic differences, not as dramatic as some of the differences that others have reported but, if you were going to put them in to two different buckets, those are the buckets that I’d put them in. I know that goes against what some others have said because in the west coast and the southeast we’re performing quite well considering the economy and we think that’s the strength of our brand in those markets.

Robert Wyler – Piper Jaffray

Then finally my last question, the commodity expectation for FY ’10, I know you guys spoke about it but overall commodity inflation do you expect modest inflation or flat at this point in time? I know a lot can change.

John R. Hartung

Well certainly a lot can change and it really is a mixed basket. Some things are going up, some things are going down. I think when you net them all together it would look like next year is going to have some net modest inflation. Nothing crazy like we saw last year, nothing flat or down like we saw last year so it seems like it would start to return to kind of normal net inflation and that would be a fine result as far as we’re concerned.

Operator

Your next question comes from Tom Forte – Telsey Advisory Group.

Tom Forte – Telsey Advisory Group

I had two questions, one is on sales trends and the other is on supply chain, it’s similar to one that was asked before but a little different. On sales trends I wanted to know where you stood day as far as day part mix lunch versus dinner and if you’re seeing anything interesting on weekdays versus weekends, if there’s a difference in sales versus historic trends? Then on the supply imitative, as the slowdown in the economy made it any easier for you to get the naturally raised beef, chicken or pork and where do you stand today as far as percentage of system rolled out to naturally raised beef?

Steve Ells

First of all, with regard to the day part mix it’s still roughly 50/50 lunch dinner, it’s actually skewed slightly towards dinner so that really hasn’t changed. You asked about mix weekday versus weekends, I can tell you that we’re sort of encouraged that we have strength in our transactions on Fridays, much more so than on weekdays so we feel like – that’s one thing that we’ve noticed that gives us some confidence that consumers still consider us a treat and even those, like Jack said, who may not have given up, we don’t feel like customers have given up going to Chipotle but some come less often. But, a lot of people seem to treat themselves on Fridays so we feel good about that.

You asked a question about supply chain and is it easier to get naturally raised meats, given the state of the economy. The short answer is no, it’s not easier. In fact, if anything, it’s harder. Pork is the easiest meat for us to keep pace with just because there is adequate supply of naturally raised pork and we are well within that available supply in terms of what we need for our growth for the midterm even long term future so in pork we’re in pretty good shape and the supplies are in good shape.

Chicken has been a real bear for us lately. The reason for that is as the economy worsened the sales of chicken breasts fell of dramatically at supermarkets, naturally raised chicken breasts. The breast meat is traditionally in the United States, the more expensive part of the chicken and the price of the breast meat was quite high and so people quickly traded away from that as their pocket books were tightened. So, when that happened, it became much less profitable to raise chickens and so a lot of the chicken suppliers have felt the squeeze from that and have either stopped raising chickens, reduced the amount of chickens that they raise or in some cases tried to visit more of the cost on to the thighs and legs which we use in order to try and maintain their profitability.

So, chicken has been really tough for us and it is very tight right now. We’re using essentially all of the naturally raised chicken that we can find that’s out there. So, we’re using a very significant part of that supply on the leg and thigh side of things. On beef, it’s kind of the same thing has happened that’s happened with chicken in the really high end, naturally raised beef cuts which are traditionally sold in supermarkets got sold at much lower rates, people were just not buying nearly as much of those really expensive parts of the animal and because of that ranchers have decided not to raise as many naturally raised animals so beef has been really tight.

We are holding to that 60% that we’re out now and we think we’re going to continue to be able to do that but we don’t think we’re going to substantially increase the amount of natural raised beef that we’re going to be able to offer, in the short term anyway, because of the economic climate. So, the short answer again is no and there was the long answer.

Operator

Your next question comes from Paul Westra – Cowen & Company.

Paul Westra – Cowen & Company

Several questions here, share repurchases you’re running out of your first tranche of I guess $100 million, what’s your appetite for maybe additional slugs?

John R. Hartung

I think we’re going to sit tight Paul. I mean clearly we’ve got more cash than we need, we’re self funding right now. We were very opportunistic when we started this last year, we started in the 30s and so we’ve been able to buy at a really attractive price, just under $54 and I think the Bs are trading somewhere around $74, something like that so they’re really, really attractive. So, we’re certainly open to it, I think we’ll certainly talk about it not only among ourselves here but also in our board meeting but nothing imminent, nothing in the very near future to report on that.

Paul Westra – Cowen & Company

Then a follow up on the marketing, it sounds like you if I’m correct here, decided kind of what to tell customers and what is resonating with them but have you found anything sort of where to communicate them changed or where the highest IRRs are? It doesn’t seem like you’re making a major shift in I guess your mix of billboards and social media and online expenditures.

Steve Ells

No, that stays the same Paul. What changes though is the message on the out of home or billboards and print and that message is shifting from www.MyChipotle.com, from promotion of that to promoting what we call taste good is good. So, the spend is the same and the places that we’re spending are the same, the message is different though. We’re going to support www.MyChipotle.com only online because we can really pinpoint people who are obviously online and a lot of people are visiting that and that’s going well.

Again, the reason we’re switching this is because we’re seeing this opportunity to really reach out to customers and talk to them in a way they seem very interested in hearing. They seem very interested in the message on the Nightline piece and they seem very appreciative of the sponsorship of Food, Inc. so we’re really going to reinforce that kind of connection through this taste good is good which talks about the importance of sustainably raised food and that by cooking with sustainably raised food we’re making better tasting burritos and tacos and that Chipotle is the only place to get that. We think that’s going to be a really important message for customers.

Paul Westra – Cowen & Company

Just the impact of minimum wage here, the new round of minimum wage hikes and it seems at least other companies are talking about this round being a little bit more impactful to the wage rates than the prior one.

Steve Ells

It makes sense that it would be more impactful for a lot of restaurant companies and a lot of our competitors because obviously it took it to the highest level and it’s the third year of the increase and the last increase under that program. But, for us it was actually no impact whatsoever. To be very specific we have about 22,000 employees, 40 had their salaries increased as a result so it’s literally completely not material. Even when we look at the sort of indirect impacts of what’s happened to our recent wage increases as compared to six month ago wage increases, they’re very similar, in fact they’re a little bit lower. So there’s been no impact at all and we don’t anticipate an impact from it.

Paul Westra – Cowen & Company

A follow up on some of the tests here in Denver and now you’re rolling out Salt Lake City here, I assume you’re not seeing any material speed of service impact from the kids menu and/or additional items?

Steve Ells

It’s interesting, the kids can take longer to order Paul but we see kids going in Denver at least to restaurants that are more suburban during lunch time which were not traditionally as busy during lunch. So, I don’t think overall we’re seeing a material impact on speed of service so I think it will be a good thing.

Paul Westra – Cowen & Company

Then my last question, reasking sort of I guess the ramping of these stores, I know you’re changing some of the locations, you talked about in the latest trailing 12 or 18 amount of classes, opening up the same range. Do you sort of still feel comfortable about this sort of three year ramp to a companywide average performance from that level?

John R. Hartung

It’s really difficult to predict Paul because this is an extreme recession that we’re in right now. Our comps have been impacted not only for our mature restaurants but also for our new restaurants as well. So, during this environment I don’t think you can expect to get to system average within three years. What we’ve done instead is take a pessimistic view if you will and say well geeze, if you start out at $1.350 to $1.4 million and you have a couple of years of like mid single digit comps which is much lower than we’ve seen historically in terms of a ramp, that gets you around $1.5 and if you use a margin of not even as high as what we just reported in the first and second quarter, just use like a 22% margin or something like that, or maybe 22.5% or so you can get to cash on cash returns by year three in the 35% to 40% range.

So, we know even if we have to just live with for a long time more modest comps, we may not get up to the $1.730 million or $1.740 million tight system average today but we still get to very superior cash on cash returns and so that tells us that our unit economic for new stores are very healthy, we should continue to invest in these new stores and when the recession subsides and we expect that our comps will bounce back for all of our stores including the new store ramp will increase, then the economics just get even better from there. So, that’s the way we’ve been communicating it.

Operator

Your next question comes from Greg Ruedy – Stephens, Inc.

Greg Ruedy – Stephens, Inc.

To follow on Paul’s question, in terms of the new marketing campaign, for a new uninitiated guest if we assume that you can leverage that educational factor at a trial how would a restaurant sort of balance the educational questioning that could pop up in the line versus just getting a guest processed?

Steve Ells

Is your question about the effect on throughput?

Greg Ruedy – Stephens, Inc.

Yes.

Steve Ells

Certainly that could be an issue. Chipotle on one hand for the regular customers is kind of the ultimate experience in that they can tailor – they know exactly what they want and they know how to use the system and there’s a learning curve to getting there. We see it in new markets when there’s a disproportionate amount of new customers and we see that they do have more questions and they’re learning the system. It’s just part of the evolution. So, more customers that are uninitiated could certainly slow it down.

But, more customers in existing restaurants might not be as dramatically slow as new customers in new restaurants because you have a mix of some regular users. We notice that new customers watch other customers sort of how to do it. So, it’s a great question, I’m not sure what the effect will be but obviously we would not want to market for fear that we’re getting too many new people in. Getting new people in to the brand is a great thing and we have a great report with customers new and old and I’m confident that our crews will delight them.

Greg Ruedy – Stephens, Inc.

I’ll shift gears to the new menu tests, any shifts in demographics say male/female or the families/individuals?

Steve Ells

I think, and no research shows this but sort of what we’ve observed is that a lot of moms are bringing their kids in for the kids menu. So obviously we had more kids in there. We’ve always had kids but it seems like the kids that were brought in were brought in by their parents who were obviously regular users. I think this kids menu now enables us to get kids who maybe tell their parents they want to go so it would obviously skew to more kids coming in.

Greg Ruedy – Stephens, Inc.

How many SKUs did you add on that new menu test and can we assume that if you move to a smaller kitchen that that would [inaudible] the new menu test if you do roll it out?

Steve Ells

Well, it’s interesting the SKUs, there were different categories of the things we added, we added the kids menu then we had the low roller menu items which were smaller portions of things. The only true new SKU was the Pizzoli soup, the other things were just new combinations of already existing things that are there. That’s kind of one of the brilliant things about Chipotle is that there are all these new combinations you can make from already existing things. So, we did not add complexity to the back of the house. We did not add complexity to the cooking, we didn’t add complexity to what the people who were on the line serving already do. So no, I don’t see this as something a smaller more efficient kitchen couldn’t handle, that doesn’t have impact that way.

Operator

Your next question comes from Steven Rees – JP Morgan.

Steven Rees – JP Morgan

I just had a longer term question on the restaurant margins, as we move closer to 2010 and the pricing rolls off and I guess leaving the commodity uncertainty aside, do you think it’s still possible to get further labor and other operating costs leverage in 2010 after the very large gains this year in 2009?

Montgomery F. Moran

Yes, it’s possible and no we don’t think it’s something that we should all count on. There’s a lot of pressures moving sort of the wrong way on margins, as many as there are moving in the right way so with regard to labor for instance, I’m cautious because last quarter during the earnings call I said that I didn’t think it was likely we could get significant more leverage and here we are 140 basis points better than we were this time last year so like I said I was wrong. Our teams in the field surprised me and proved me wrong in a very nice way. But, this isn’t something, specifically labor isn’t something and in fact all of our operating costs aren’t things that were managing from this office by saying, “Drive them down, down, down.”

Our primary focus is on a top notch customer experience, clean restaurants, great customer service and making sure to delight each and every customer. We’re delighted by the margin we have now. We are not going to push our teams in the restaurants to continue to try to find labor leverage unless they find it through making the operations better and through having much, much better teams. So, they’ve proved me wrong in the past, it would be nice if they continue to prove me wrong but the number one thing that we’re going to be looking for is that our operations continue to improve and get better and better.

Steven Rees – JP Morgan

Then just finally for me, I guess I didn’t see it but are you still endorsing sort of the longer term 25% earnings growth outlook? I mean obviously you’re going to be well above that this year and I guess if so, how do the components of that change with units being relatively flat in terms of absolute number of units? How are you thinking about the components of the longer term earnings growth rate going forward?

John R. Hartung

We took the formal long term guidance of 25% off the table some time last year just as the economy worsened and it became clear that it’s very, very difficult to predict. Over time, we still think that we’re a significant growth company. We still think we have the potential to grow in that kind of a range but without knowing what’s going to happen to consumer confidence, what the next wave or if there is a next wave of commodity inflation. It’s tough to reinstitute that. Clearly, we’re going to have a great year this year. If you combine this year and last year we’re probably on top of the 25%. We think over time yes, we can do that but we haven’t been formally communicating that just because it’s been such a difficult environment.

Operator

That’s all the time that we do have for questions today. I’d like to turn the call over to Chris Arnold for any additional or closing remarks.

Chris Arnold

That will do it on our end. Thanks to all for joining us and we’ll talk to you again in three months.

Operator

This does conclude today’s conference. We thank you for your participation.

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Source: Chipotle Mexican Grill, Inc. Q2 2009 Earnings Call Transcript
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