Chipotle Mexican Grill, Inc. Q3 2009 (Qtr End 9/30/09) Earnings Call Transcript

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


Thank you for standing by, and welcome to the Chipotle third quarter 2009 earnings conference call. (Operator Instructions)

I'd like to at this time now turn the conference over to Chipotle's Investor Relations Director, Kate Giha.

Please go ahead.

Kate Giha

Thanks, Duane. Hello, everyone, and welcome to our call today.

By now you should have access to our earnings announcement released this afternoon for third quarter 2009. It may also be found on our website at in the Investor Relations section.

Before we begin our presentation today, I will 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 discussion of our real estate strategy, the number of restaurants we intend to open, projections of the restaurant comp sales and transaction trends, new restaurant development costs 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 annual report on Form 10-K for 2008 as updated in our subsequent 10-Qs for discussion of the risks that could impact our future operating results and financial condition.

I'd like to remind everyone that we have adapted 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 fourth quarter it will begin December 1st and continue until our fourth quarter release in February.

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

And with that out of the way, I would like to turn the call over to Steve.

Steve Ells

Thank you, Kate.

We're pleased with our third quarter performance, particularly in an overall operating environment that remains challenging. For the quarter we delivered a 2.7% comp and saw revenues increase 13.8% from a year ago. This brought our revenue to $387.6 million for the third quarter and led to diluted earnings per share of $1.08, an 83.1% increase from the third quarter of 2008.

Our performance continues to be driven by our disciplined approach to our business and our constant efforts to improve every aspect of what we do. In recent months these efforts have included looking at our menu and working to upgrade some of our ingredients, reexamining our marketing strategy and direction, and taking a fresh look at the way we design and build our restaurants, and working to improve our real estate strategy. This approach to running our business allows us to continue to deliver solid financial performance and excellent returns for our shareholders, while continuously improving the customer experience.

As we discussed during our last call, we have been testing an expanded menu in our Denver restaurant since April. That expanded menu includes some featured items, small items at lower prices and a kid's menu. So far, the kid's menu items are proving to be the most appealing change to many of our customers. Based on that we have decided to expand the test to include the rollout of the kid's menu to five other markets - Boston, Arizona, Wisconsin, Dallas and Sacramento. The kid's menu is now available in these markets as well as the Denver and Utah markets, and we'll watch to see how it's received in the sampling of markets before we make any additional plans for it.

In the meantime, we're interested to see how the demand for our Posole, too, changes as we move into the cooler months. So we'll leave that on the test in the Denver menu for now. As for the small items at lower prices, while our research shows that customers appreciate these options, sales of these items are not strong, and we're assessing what we will do with these items going forward.

With regard to our marketing, we have wrapped up the majority of our My Chipotle user-generated advertising campaign, which continues as an online program, and are redirecting the focus of our marketing to speak more explicitly to our food philosophy. Specifically, we're pursuing advertising which relates to the great taste of our food and the high quality ingredients we use.

Our customers love the great taste of our food, and we believe building more awareness about our efforts to source great ingredients and cook the food we serve in our restaurant will strengthen that bond that we have with existing customers while helping to reach new customers as well. Much of our current advertising reflects this direction, and we are now working on a new campaign and creative for 2010 as well.

Beyond our menu and marketing, we're also taking a fresh look at how we design and build our restaurants. Our earliest restaurants were generally smaller, simpler and very efficient. As we grew, our restaurants became larger, more architecturally complex, and in some instances less efficient than before. Our aim is to evolve the look of our restaurants while returning to our roots of designing restaurants that are simple and more efficient and to do this in a way that continues to build on the iconic brand that we have established.

To do this we're going to employ design changes that are more than simply a veneer or a new look. Certainly, the aesthetics are important to us, but it's also important that the design says something about who we are and what we stand for. We want the design to make a connection between our simple, high quality ingredients and the way we prepare them and the way we choose the materials and build our restaurants.

Just like our simple menu, the new design focuses on only a few things. It is less cluttered and fussy than many of the restaurants that we have built in the last decade and uses the architectural design to suggest a flow in the restaurants rather than physical barriers. In the kitchen and along the service line, workstations are clearly defined and provide ample space for our crew to work, but use space efficiently so none is wasted. And we are using materials like white tile on the kitchen walls instead of stainless steel that are easier to clean and maintain.

We're also working to design things in a way that uses less energy both in the manufacture of the materials and the energy required to run the restaurant. The lights require less energy to illuminate the space, and the materials and kitchen equipment are more energy efficient so that the new design should reduce our environmental footprint.

I'll turn the call over to Monty now, who will speak about how these design efforts will be combined with our real estate selection strategy to allow them to strengthen our real estate portfolio in the future.

Montgomery F. Moran

Thanks, Steve.

Our strategy for selecting real estate has always been to find great, high visibility locations in trade areas that have a combination of large daytime populations combined with strong traffic counts and residential populations where possible. Following this strategy, we've been able to maintain rapid growth, establish the Chipotle brand in markets around the country, and continue to generate strong unit opening volumes.

Even in this economy our new restaurant unit economics are very strong. If anything, our new opening volumes are even stronger in recent months. This has been a result of the real estate strategy that we have often described to you, essentially opening two-thirds of our new restaurants in proven markets and opening one-third of them in what we call new and developing markets.

As we have described, our new stores overall have been opening in the $1.350 million to $1.4 million range, with the two-thirds that we open in the proven markets above that range and the third that we open in new and developing markets opening more in the $1.1 million range. Openings in our proven markets typically generate superior returns right away, and new and developing markets take longer to deliver the returns that we're looking for.

While we're delighted by the continued strength of our new store openings, we think that there's an opportunity to make our real estate strategy even better. This is especially true given the recent pressure on developers and the corresponding reduction in the number of new developments currently available for us to buy or lease. Keep in mind that these new developments have historically accounted for the majority of our new store openings.

In light of this situation we want to find a way to continue our brisk pace of new restaurant development while maintaining a disciplined approach to our site selection, taking advantage of favorable occupancy costs available in this environment and protecting or even improving our unit economic model. We believe that we've found a way to do this.

Most of our new restaurants will continue to be built in what we call Tier 1 trade areas. These are trade areas that generally have high occupancy costs and high development costs but which are great opportunities for us because of the very high sales volumes that we're able to attract to these locations.

We now plan to expand upon that strategy by pursuing additional restaurants, which we're calling A Model sites. The A Model sites will be built primarily in Tier 2 trade areas, which still have attractive demographics but are typically characterized by lower occupancy costs and which we can develop for a substantially lower investment cost.

What excites us about these A Model locations is that due to these lower occupancy and development costs, coupled with our ability to operate these sites with lower operating costs, we believe that we can achieve cash-on-cash returns in the mid-30% range or better even at sales volumes in the $1.1 million range that we have normally achieved in the third of our stores that we build in new or developing markets.

This new strategy provides many benefits to us. In the short term it bolsters our real estate portfolio while the sluggish economy limits the availability of the new developments that we have traditionally pursued. In the long run, it broadens the potential inventory of sites that we can consider as well as the number of markets that we can profitability pursue. With this A Model strategy we plan to maintain our current pace of new store growth, adding between 120 and 130 new stores in 2010, with as many as a quarter of those locations being Model A restaurants.

Again, our Model A project is not intended to replace our traditional strategy. Instead, it will be a course of action that we pursue in tandem with our ongoing effort to pursue as many traditional Tier 1 locations as we can find.

This new direction allows us to penetrate existing markets more deeply, bringing the Chipotle experience closer to more of our customers and making us more convenient. Initially we will pursue A Model locations in proven markets where our presence is already well established, places like Washington, D.C., Chicago or Minneapolis, for example; however, once validated this strategy will also allow us to grow more efficiently and aggressively in new and developing markets as well.

We're committed to this new strategy and believe that it has significant benefits for us both in the short and long term, letting us continue to pursue strong unit growth even in a sluggish economic climate while improving our ability to compete in locations where we would not formerly have been as eager to add restaurants. This will make us more convenient and accessible, allowing us to bring the Chipotle experience to more customers throughout the country.

And with that I will turn the call over to Jack.

John R. Hartung

Okay. Thanks, Monty.

Overall we're very pleased with our third quarter results. Despite the fact that transaction trends remain soft, we were able to produce impressive EPS growth of 83% from Q3 of last year and generate industry leading operating margins as a result of our continued disciplined approach to running the business.

Our top-performing crew and management teams continue to do an incredible job, delivering great customer service while efficiently managing their restaurants, and our corporate and field support staff continue to find ways to accomplish more with less. Our people culture and our business model are the strongest they have ever been.

Revenue for the third quarter increased 13.8% to $387.6 million from $340.5 million last year. Revenue growth was driven by new restaurants not in the comp base and a 2.7% increase in comps. The comp growth was driven by the 6% menu price increase taken in the fourth quarter of last year, partially offset by negative traffic of around 2.5%. The average check was up around 5% from last year, slightly less than a full price increase. Assuming no trend change before the end of the year, we continue to expect comps in the low single-digit range for the full year.

In the fourth quarter we will lose more than half of the menu price increase from last year as the menu price effect will drop to about 2.5% in Q4. As we look to 2010 we remain conscious about the economic environment and without any signs of improvement in consumer discretionary spending, we expect transactions and sales comp trends during 2010 to be flat. We don't have any current plans to increase menu prices at this time, but that may change depending on inflationary pressures and consumer spending levels.

EPS for the quarter was $1.08, up $0.49 or 83% from last year.

Restaurant-level margins were 25.5%, up 410 basis points from last year. The positive effects of the menu price increase, along with efficiencies in labor, were partially offset by deleveraging from fewer transactions while lower promotion and utility expenses in the quarter helped fuel the higher margin.

Food, beverage and packaging costs for the quarter decreased 220 basis points from prior year to 30.8%. This decrease was mainly driven by the impact of the menu price increase and cost decreases for cheese, avocados and steak, and was partially offset by the increase in rice.

Labor improved 140 basis points from the third quarter of 2008 to 24.9% as our restaurant teams continued their focus on hiring and retaining only high performers, allowing our restaurants to run better and more efficiently than ever. We expect this labor leverage to decline or even disappear over the next two quarters as we open many more restaurants in the fourth quarter, as we lose the benefits from the price increase, and as we begin to lap labor efficiencies generated in the first quarter of this year.

Other operating costs decreased 80 basis points from last year to 11.4% of revenue. The decrease was mainly driven by lower promotional and utility costs, but also included incremental savings across many other lines such as laundry, repairs and maintenance, and restaurant supplies.

Marketing was only slightly higher than last year at about 1.4% of sales as we ended our ad support for My Chipotle during the quarter. We plan to increase our promotional activity in the fourth quarter, which will include residential mailers in many of our markets as well as our Halloween BOO-Rito event, where customers who dress in a Chipotle costume receive a free burrito on Halloween.

G&A decreased 30 basis points from last year to 6.3% of sales, and the decrease was the result of the menu price increase and decreased travel costs partially offset by a higher bonus accrual.

Our effective tax rate for the quarter was 37.2%, which was the result of adjustments to lower our estimated annual tax rate to 38.1%. The annual rate reduction was driven by adjustments related to our meals and entertainment deduction, federal tax credits, and benefits relating to our food donations under our Harvest program. We expect our tax rate to be about 38.1% overall for this year, and about 38.5% in 2010.

We opened 26 new restaurants in the quarter and 76 for the year so far, bringing our restaurant count to 911. And we continue to expect to open about 120 to 130 for the full year.

As we look to 2010, we plan on opening around the same number as this year - in the 120 to 130 range - and while opportunities in new developments continue to decline, that has been offset by a greater number of available existing spaces, many of which will be A Model sites that Monty discussed. In fact, as many as 25% of our openings next year will be A Models. And because these new restaurants are expected to be designed and constructed at a much lower cost, we expect our overall investment cost to be around $850,000 next year on average, lower than the $900,000 we expect for this year.

Our new restaurants have continued to open at volumes in the same $1.350 to $1.4 million range we've been talking about for some time now. As we begin to open A Models next year, assuming our new restaurant volumes hold in the same range, our new restaurant returns will increase as a result of the lower investment costs, lower occupancy, and lower operating costs of the A Models. Even if our new restaurant sales should dip a bit next year, we still expect new restaurant returns at or above our current levels.

Since we plan to open A Models only in proven markets next year, we are very confident about the quality of our portfolio. And as the A Model strategy gains traction, we will begin to explore A Model openings in newer and developing markets, where we expect this strategy will lead to more aggressive growth and more attractive returns in these markets.

We're also pleased to announce a proposal to convert our two classes of stock into a single class. After many months of working to satisfy the requirements of our separation agreement with McDonald's, we've received an unqualified opinion of counsel that has been approved by McDonald's that the share conversion will not impact the tax-free status of our split off. This was a difficult and complex challenge, and we thank McDonald's for working with us through this process to make it happen.

We've planned a special shareholder meeting for December 21st, where shareholders will vote on the proposal. A proxy statement will be available electronically beginning the week of November 2nd, and assuming shareholders approve the proposal, we would expect the combination to be effective on or about December 22nd. At that time the CMGB class of stock would cease trading, and the new Chipotle common stock would continue to trade under the ticker symbol CMG.

Thanks for your time today. At this time I'd like to open the line for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Jeff Farmer - Jefferies & Co.

Jeff Farmer - Jefferies & Co.

Could you just provide some additional local on your local store marketing and direct mail efforts? I guess, more specifically, any changes you've made there in the last couple of quarters?

Steve Ells

Yes, actually. Since August we've done a lot more direct mail, especially. We had a big buy one, get one free mailing in Boston, and we got great redemption on that. And we're planning on a doing a lot more of these direct mailings. We've refined the way we do this, so we get great redemption on those.

Jeff Farmer - Jefferies & Co.

And then Monty, you gave us a lot of color on the new versus existing market development and the new A buildings, but in terms of looking at, I guess - well, let me take step back and see what's most important here - softer same-store sales in the Midwest markets, so a ton of color on new versus existing markets, but as you look at those softer Midwest markets, from a development standpoint are you able to sort of avoid development in those markets for now?

Montgomery F. Moran

I'm sorry. Can you say it again? I didn't mention anything about softer same-store sales.

Jeff Farmer - Jefferies & Co.

I'm sorry. On the last call you had highlighted that, in terms of where you're seeing weakness from a same-store sales perspective, the Midwest markets were among the softer regions, and I was just curious in terms of development in 2010 how you sort of incorporated that softness into the development plan for next year?

Montgomery F. Moran

Well, I mean, you know, the difference between the Midwest and other parts of the country is pretty subtle, so it really doesn't play very much into our real estate strategy. We still have a lot of great growth to go in that region of the country as well, so that really isn't a big part of our real estate strategy at all.

Jeff Farmer - Jefferies & Co.

Jack, you touched on this, but the advertising spend for this year, as you look into next year in 2010, as a percent of revenue what does that look like?

John R. Hartung

Yes, Jeff, I would expect we'd return back to right around 1.75%. But, as Steve mentioned, we're really redeveloping, revising the next phase of this, and so we're going to be very thoughtful as we spend that. We're going to I think develop creative, develop a strategy, begin to roll that in various markets, and as we feel good that the strategy is working, you know, that it's connecting with our customers and communicating what we want to communicate, then I think we'll ramp up our investment.

So we don't know exactly how we're going to invest right now quarter by quarter, but we're going to do it thoughtfully and kind of make decisions along the way. But overall I would expect us to be in the same kind of range, this 1.75% that we've been talking about for the last few years now.


Your next question comes from Matthew Difrisco - Oppenheimer & Co.

Matthew Difrisco - Oppenheimer & Co.

I might have missed that, but in responding to that question did you also say that full year for '09 you're still guiding to 1.8% or what's '09 going to look like for marketing?

John R. Hartung

We'll be lower. We're at about 1.5% for the year. We're about 1.4% for the quarter. That's largely because we pulled back on My Chipotle. We didn't invest as much as we had originally planned. And rather than just continue to invest the money at that same rate, we really pulled back on the investment, and we'll reinvest again once we have our new strategy fully developed.

So I think overall for the year we'll probably end up in that 1.5%.

Matthew Difrisco - Oppenheimer & Co.

And then just looking at the A Model locations, how comfortable are you or how much have you tested that this might not cannibalize given that it sounds like you're maybe increasing your development schedule into existing markets? I can recall, I think, when Bistro did this, P.F. Chang got a little close to some of their stores, there was a little bit of cannibalization. Are you concerned that these smaller models might cannibalize some of your stronger existing markets right now?

Montgomery F. Moran

If anything, we feel more comfortable that we can find brand new trade areas that will likely cannibalize less. We've always looked at impact. We've done I think a very nice job of identifying when impact might exist of being able to measure that impact. And we always make decisions based on a post-impact result. So frankly, we're not really that worried about impact at all.

Matthew Difrisco - Oppenheimer & Co.

And then just last question - are these stores going to be open in general the same amount of hours or are these trade locations that might be smaller locations designed for optimizing maybe one very strong day part, whether it's primarily lunch or something in an urban area?

Steve Ells

No, initially we're looking at these as being the same exact operating hours as our existing restaurants. We have some flexibility around the country sometimes to open a little earlier for places where there's a crowd coming right at 11:00, and sometimes we'll consider opening a little later. But you won't see these will be abridged much in terms of what they're offering.

Matthew Difrisco - Oppenheimer & Co.

Well, I guess I'm thinking, have you had a strategy towards that a little bit, on going back and looking at some locations? I specifically am thinking of a couple in New York that I know you've brought down to 4:00 - 4:30-ish type closings now, and I'm just curious if that's part of the labor optimization possibly?

Steve Ells

Well, not so much. That has happened in the past, but that's almost totally in urban locations, in New York and in downtown Chicago, where some of our restaurants really don't lend themselves to a strong dinner.

However, for instance, in some Chicago locations where we weren't experiencing a very strong dinner and where we used to close at 4:00, even some of those we've experienced some demand for dinner, and we're opening some of those a little later, 5:00 and 6:00 in some cases.

But yes, that's usually just a solution for an urban location with very, very little dinner time.

Matthew Difrisco - Oppenheimer & Co.

I'll turn it over, but I just had one last question on same-store sales with respect to your guidance - unchanged. Are you looking at the current trends of the stores that are going to roll into the comp base or the most recent stores that have rolled into the comp base, those larger $1.4 million plus openings? Is that reflective of how they are comping as they enter given that they are closer to, for lack of a better term, capacity, that there's less growth opportunity and they might be even decelerating a little bit in that 14th and 15th month as they enter the comp base?

John R. Hartung

Well, no. I think that's reading way too much into it. Really, when we talk about the - I assume you mean the flat comp guidance for next year - what we're talking about is we've got a comp going this year that is largely driven by menu price increases. We don't have plans to increase menu price increases for the foreseeable future, and so we expect that we will lose that benefit and return to just a scenario where we just have flat comps going forward. It's really a function of the economy, that consumers are not out spending as much.

In terms of our new stores, our new stores continue to ramp, so there's no signs of any kind of weakness at all in our new stores.


Your next question comes from Nicole Miller Regan - Piper Jaffray.

Nicole Miller Regan - Piper Jaffray

Jack, I'm sorry I missed this. For the 2.7% comp, can you please repeat the price, mix and traffic components?

John R. Hartung

Yes. On the 2.7%, Nicole, we had 6% price, we had about 2.5% negative transactions, and then we lost about 1% in the check. In other words, the check increased by about 5%; it didn't increase by the full 6% menu price increase.

Nicole Miller Regan - Piper Jaffray

And in the context of flat comps for next year, talk to us about breakeven or margin expansion. Obviously, a 3% comp today is generating a 25% to 26% store level margin, but give us some scenarios for each 1% comp change, what it would do to margin or however you want to talk about it.

John R. Hartung

You know, Nicole, the difficult thing about next year is we just don't know what the top line's going to do. We don't know what consumers are going to do, and our best guess right now based on no signs that the consumer's out spending more is flat transactions and flat comp sales.

The way to think about it is in a perfect if there was zero inflation and you had zero comps, our margins would hold up exactly as they are today. If you have a little bit of inflation - let's say it's 1% inflation across the board, across labor, across food, across everything - that would hit your margin for about 70 basis points; 2% inflation across everything would hit you for about 140 basis points. If the consumer confidence in spending does increase and you can raise prices, if you can raise prices for every percent inflation - if inflation's 1%, you raise prices 1% - your margins hold exactly; if inflation's 2%, you raise prices 2%, margins hold exactly.

In terms of if you don't raise prices and you have inflation, you pretty much have to have about maybe 1.5% to 2% in comp for each percent in inflation to hold the margins and not raise prices. So that's kind of the way to think of the different pieces.

The best scenario for us and really probably the whole industry is that consumers become more confident. They come out and they spend more. They visit our restaurants more. And then if there's inflation that creeps in we have both additional transactions and probably the ability for a modest price increase so that we can, to the best of ability, hold onto our margins. That's the way I would think about it.

Nicole Miller Regan - Piper Jaffray

And remind us, what price are you running on now for the fourth quarter that soon rolls off?

John R. Hartung

Fourth quarter will drop from the 6% effective in the third quarter to 2.5%, so we're losing more than half of that menu price increase. And obviously, by the time we get to January 1 we'll be at zero.

Nicole Miller Regan - Piper Jaffray

And just quickly on the A Models, if you take all this into consideration and you're going to be somewhere around - maybe it's 900 stores that you in or just over that - with this model, what is the opportunity domestically now? And then give us a quick update on international.

Montgomery F. Moran

First of all, we are at 911 stores right now, Nicole, so you're going to see it be quite a bit higher by the end of the year because we were back loaded this year in the fourth quarter. So it'll be sort of the 950-ish range, without doing the math.

And, oh, yeah, your question also was about the total amount of stores that we can build. We've been sort of careful never to pin this down because, frankly, we don't know, but we've always talked about sort of we can build thousands of them based upon the sort of penetration that we have in our markets like Denver and Ohio and some other markets.

You know, we're not sure if the A Model strategy will just allow us to get to that number in a very responsible way with better returns or whether it will actually increase the potential number; it's just too early to tell. But either way we think that we'll have a much stronger business model going forward with the A Model strategy.

Steve Ells

And with international, we have Toronto running very, very strong. We're very proud of the way we entered that market, and we are actively - in fact, we have folks there right now - looking for the next few sites there.

London will open up second quarter of next year, and we're just in the final stages of securing our first deal there. It's in an excellent trade area. We're very confident it's the right place to start in London. And we have our architectural plan largely complete, and we're anxious to start construction soon.


Your next question comes from David Tarantino - Robert W. Baird & Co., Inc.

David Tarantino - Robert W. Baird & Co., Inc.

Getting back to the A Model strategy, if you take a step back could you talk a little bit about the genesis of that strategy? Did you start thinking about that as you looked at the landscape and maybe you were running out of opportunities for those Tier 1 sites or is this something that was developed based on the slowdown in the broader commercial environment?

Montgomery F. Moran

You know, really we look at the A Model as a way of strengthening our portfolio. It does, we think, give us some additional opportunities to look at, but primarily we look at it as a way to strengthen our unit economic model.

We've never been a company that's tried to grow fast for the sake of growth. We've only grown as fast as we could find great real estate and great managers and, of course, while pursuing a strong unit economic model. So this is a way we see of just being more responsible in our growth, not to chase growth in a way that's overly aggressive.

David Tarantino - Robert W. Baird & Co., Inc.

Jack, a question on the inflation outlook for 2010 as a follow up to the prior question. If you take the cost picture you're seeing today, would you expect to see inflation or deflation next year?

John R. Hartung

You know, there's a few items, David, that there's going to be deflation. Unfortunately, though, they're some of the smaller items that we buy. The items that we buy the most of - and that would be our meats and cheese, in particular - there continues to be pressure on those items.

Now, we've seen pressure, pressure on the business model especially on the chicken, the beef and the pork, throughout this year, but there hasn't been really the pricing power. And so the inflation that we thought would happen throughout this year never happened; that pressure is still there. I think eventually that's going to have to lead to some inflation next year. And when it comes I think the inflation that we would expect to see with those items, with the meats and the cheese that I mentioned, will be somewhat offset by produce items and soy and rice and wheat, which all look like they're favorable.

But I would say the net-net is probably a low single-digit inflation next year if I was going to have to predict right now.

David Tarantino - Robert W. Baird & Co., Inc.

And just to clarify, that's all commodity cost inflation. How about the other costs that you were talking about on the restaurant?

John R. Hartung

That's all commodity. And, David, our wage inflation, I would expect that to be somewhere between the 2% to 3% range.

Those are the two major items, and then after that the next biggest item would be utilities, energy costs, which, you know, those look pretty good right now. But I think the commodities and the wage, both look like they would end up probably in that low single digit range as a net-net.


Your next question comes from Jeff Omohundro - Wells Fargo.

Jeff Omohundro - Wells Fargo

First just a housekeeping question: On the 2010 unit development, do you expect a weighting similar to this year with a heavier second half of the year in terms of the number of openings?

Montgomery F. Moran

Yes, I think you'll see it'll be more even in 2010 in terms of our unit openings, but it will still be weighted heavier towards the end of the year.

Jeff Omohundro - Wells Fargo

And then second, on the marketing strategy and where you go from here, I'm just curious, do you go back to an agency review and really take a fresh start at this process or is it more incremental do you think?

Steve Ells

Well, let me back up a little bit to answer that. We've tried a lot of different things in the last couple of years.

You know, we have done two things really, really well in our 16 plus year history, and one is really creating a food culture that has extraordinary food and we can cook from scratch according to classic cooking techniques. And the second part is we have this really empowered team of high performers that delivers great customer experience. And I would say that those are our two really strong core competencies for the past 16 years.

And we have grown the business in a tremendous way without having marketing be part of that core competency; but we also seem to get a very [inaudible] message across at the same time. And I think what we've learned after trying a lot of things in the last couple of years is that we have a very special story that once people hear and understand they become very attached to the brand. And we have decided that we are going to focus our efforts so that our campaign coming out in early 2010 is focusing on that idea, is good, tastes good. That we invest in high quality food so that we provide not only really great-tasting food but also food that you can be proud of, sustainably raised food, food that's healthful, food that you feel great about feeding your family.

And that really is our strength.

And while we've had interactions with some good firms, we think that we have a lot of great internal marketing power right now. And so we don't feel the need to go back out to a new agency at this point, but rather to focus our efforts on our core competency, which is that food. That's what people come from. We're going to make that connection between buying great ingredients and delivering exceptional food.


Your next question comes from Steven Rees - J.P. Morgan.

Steven Rees - J.P. Morgan

The labor leverage this year has been exceptional, especially over the last two quarters, and I guess originally you sort of guided to not expect as much in the third quarter as you lapped some of the initiatives that began in the second half of last year. So can you talk about sort of where the upside was on the labor line versus your original expectations this quarter and how we should think about labor leverage in 2010 in a flat comp environment?

John R. Hartung

Yes, Steven. You know, on the labor leverage we had talked about 100 basis points of that being recurring. Frankly, we had just gotten it a little bit more efficient in the third quarter.

We put a matrix in place - and the matrix is based on our best performers - and our teams really hit and even beat that in the second quarter. And so, although the 140 basis points of leverage that we saw in the second quarter, some of that was inefficiencies from the year before that weren't in the third quarter of 2008, frankly, our teams, they raised the bar again. They did another great job in the third quarter. So they outperformed the matrix by even more.

So we put the challenge out there based on our top performers; they met the challenge and then they beat it again. So that's really a tribute to how strong our teams are out in the field.

And then what's most important to note is as we move into the fourth quarter and then into the first quarter, we're losing a lot of that benefit because we're losing the pricing benefit, we're opening up a lot of stores in the fourth quarter - nearly double what we've opened in the first three quarters. Those typically open very inefficient from a labor standpoint. We don't try to control labor very tightly in the first month or two with our new restaurants.

The fourth quarter also is seasonally just, you know, has lower sales, and so our labor does tend to tick up in the fourth quarter anyway. And then when we move to the first quarter, we started to see labor leverage in the first quarter this year, and so we're going up against that.

So the significant benefits that we've gotten and that we're proud of will really start to fall pretty quickly here in the fourth and the first quarter.

Steven Rees - J.P. Morgan

And then just in terms of, you know, it sounds like the A Models are slightly lower cost. Can you talk about your total CapEx over the next year, 2010 versus 2009.

John R. Hartung

Yes, it should be lower. I think this year, depending on how many we actually get open before the end of the year, we expect this year to be in kind of the $130 to $135 million range. Next year we would probably be like in the $125 million kind of range, again, depending on exactly how many we open next year.

Steven Rees - J.P. Morgan

And then just finally the flat comp outlook, I assume that's a full year sort of goal? Should we expect there to be any progression throughout the year? Does your model assume any sort of economic improvement, slightly negative first half, more positive in the second half or are you expecting flat across the board?

John R. Hartung

I will tell you, Steven, it's really difficult to predict with that level of precision. I mean, there's changes depending on what the compares are from last year, but generally I would think we're thinking of a relative flat throughout the year and then there might be trading day adjustments depending on how many Fridays and Saturdays you get in a month. But generally it's kind of flattish throughout the year.

We're predicting no economic improvement, and we're predicting that because we've just not seen signs of any economic improvement.


Your next question comes from Sharon Zackfia - William Blair & Company, LLC.

Sharon Zackfia - William Blair & Company, LLC

I think on the A Model sites, if I said that correctly, it might be helpful if you give us an idea of what a location would be? I kind of understand your language, but I'm not sure how to reconcile that with a Chicago site or a Washington, D.C. site.

Montgomery F. Moran

Okay. Well, you know, when we go out and look for locations, like I said, we normally start with the Tier 1 locations, which are the real high traffic count, a lot of daytime population, hopefully some residential where we can - you know, we generally start out focusing on a really, really long lunchtime - I mean, a really, really strong lunchtime, and also the possibility of developing a really good dinner business so we can have a good balanced operation.

You know, with the A Models there's really nothing too mysterious here. The fact is we've done a lot of these Tier 2 locations in the past. It's just they haven't been our primary focus. When we open the stores in the $1.1 million range, that has been something that historically for us has been a bit of a disappointment for us, and we've talked about it that way - that those are our weaker stores or our weaker markets, where we open doing $1.1 million.

We got to thinking there's really no need to look at those as low performers. It would be better to turn opportunities like that into high performing restaurants by taking advantage of lower occupancy costs which are available particularly in this economic climate but also in some of what we call Tier 2 locations.

But also our ability to develop them for a much lower development cost, since these locations are going to be smaller in terms of square footage - usually 1,800 to 2,200 feet instead of our average now, which is 2,400 to 2,500 feet - and with some things that we can do differently in the development we can bring down that development cost quite a lot in the smaller square footage space.

And also we have the lower occupancy cost that I mentioned, and finally we're able to operate them better and less expensively through a number of operational efficiencies that we've achieved.

So we've already begun working on the operational aspects of this in a number of our existing restaurants that are the lower volume restaurants to prove out the fact that we can operate them more efficiently, and it's working. It's working quite well. Some of that is some of the labor efficiency that you've seen over the last months and the last quarter.

And so, anyway, we're excited about the opportunity to keep doing this, but do it more deliberately and going in and developing them for the proper cost to make it a win right out of the gates instead of something that we're sort of feeling is not our top performing restaurant.

Sharon Zackfia - William Blair & Company, LLC

I don't want to get ahead of anything here, but given that you have experience with these kinds of sites already, I mean, is it possible that you're kind of underestimating the return potential? I would think that the sales could be a little bit better than you're alluding to and the margins a little bit better as well.

Montgomery F. Moran

Frankly, yes. I think that right now what we're doing with the A Model locations is we are starting out using the A Models in our proven markets. And, as you know, the proven markets are those which have typically opened with a higher volume. But keep in mind we're going into those markets and going into Tier 2 locations, which we would expect would have a lower opening volume.

That being said, are we wide open to and optimistic that there will be some upside surprise on some of these A Models? Absolutely, yes. But I guess the important point is we don't need that to be the case in order to really enjoy the returns that we believe we'll get from these A Model sites.

Sharon Zackfia - William Blair & Company, LLC

And then lastly, Jack, you've seen that traffic trend become a little bit less negative now for a couple of straight quarters. Has that been a kind of consistent trend, where things are firming a little bit for you, or is it just pretty volatile and that's just how the numbers kind of shake out at the end of the quarter?

John R. Hartung

Well, you know, I think it's relatively volatile, although I would say that, to the extent that there's been gradual improvement throughout the quarters and throughout the individual months, it's really been driven more by the compares than it has been by trends. When we just look at the trends and forget about the compares to last year, we generally have seen mostly a sideways trend, if anything maybe a little softening, incremental softening as we've gone month to month or quarter to quarter.

And so any of the improvement we've seen is more from a comparison than a strengthening of the consumer.


Your next question comes from Bryan Elliott - Raymond James.

Bryan Elliott - Raymond James

I wanted to circle back and maybe follow up a bit on Sharon's question. You spoke to sort of inefficiencies creeping in the traditional footprint, and I guess as I look at your numbers it's really hard to see any inefficiencies. Maybe you could give us an example or two of what those creeping in inefficiencies with the old prototype were?

Steve Ells

Sure. Well, you know, I'll start with the kitchen. Over the years, we went through a 10-year period of double-digit comps, and as we saw our volumes go up, we needed to react to those volumes. So as we built new restaurants, we built them bigger. We were cooking a lot more chicken and steak on the grill, so we got a bigger grill. In order to accommodate that bigger grill, you have to have a bigger hood. In order to have a bigger hood, you have to have more make up air and have a larger air conditioning unit on top. In order to do that, you have to have more power coming to the building.

And there's a ripple effect where everything sort of starts bursting at the seams. And this resulted in greater and greater investment costs, but the investment cost was justified because our sales were going up.

But if we look at instead of getting bigger getting more efficient through the use of technology and being more efficient in the way we lay things out so that there are fewer footsteps taken and things like this, we see that we can satisfy larger volumes and decrease investment.

I think one great example of this is our new grill. We've switched to a more European-style plancha, which is a flat-top grill as opposed to the griddle, and we've reduced the size of it. We've reduced the amount of heat it puts off. It requires a smaller hood that has less CFMs and so on and so forth. And there are many, many examples of this just in the kitchen alone.

Bryan Elliott - Raymond James

And so the time and motion study footprint, that sort of thing is where the labor efficiencies can come in relative to the old model? You just need sort of fewer man minutes on the line?

John R. Hartung

No, Bryan. Really, Steve captured the efficiencies. We are very efficient from a labor standpoint. But if the kitchen is smaller it means there's less to clean. If the hood is smaller, that means energy costs go down, the investment costs go down. So it's really more in the design that's just added square footage and added more space to clean that we think we can find efficiencies.

Some of the other efficiencies that Monty talked about is just the fact that we can run a restaurant with one salaried manager instead of two. And you know what? We're already doing that. We've already taken this year all of our restaurants that are below a certain volume - say $1.4 million - and we're running them with one salaried manager. And you know what? They're running better because our best top performing people are empowered now. They can do more .And people get excited when a service manager, for example, can step up and do some of the work that an assistant salaried manager would do. And so we're seeing a lot of great results from that.

But from the A Model standpoint, it's these efficiencies from the way we design them from the very first time we look at how big the kitchen needs to be and how big the grill needs to be that we expect to see some pretty significant benefits.


Your next question comes from Jason West - Deutsche Bank Securities.

Jason West - Deutsche Bank Securities

Just another one on the new prototype and just a general store outlook or store opening outlook: I guess if you look at the numbers you're targeting next year - 120 to 130 - that's kind of a deceleration in the growth rate, obviously on a bigger base. It sounds like you guys are still very optimistic about new store productivity and the returns and you've got this new prototype that lets you go into more locations. Why is the growth rate coming down to kind of a 12% - 13% number?

Montgomery F. Moran

Well, there's a few things at work. Number one, let me just back up again and say we've never been a company that's tried to grow for the sake of growth; we really want quality growth. And if you look at the kind of stores that we opened over the last many years, we tended to open most f our restaurants - 60% or more - in new developments.

There are less new developments now. That was true in 2009; it will be true in 2010, maybe even 2011 because it takes awhile for these things to come back online. And given this economy and given the inability of getting financing, the insecurity landlords have in trying to find a good tenant mix and so forth, there's just not as many of these developments being built.

And since those were the majority of what we put our new restaurants in, that has created a decline in the number of really high quality sites that are out there for us.

This A Model strategy does give us a way of taking advantage of some of the opportunities that have arisen, though, in this climate, where we can go into some existing locations, like I said, Tier 2 locations or call them in-between locations sometimes, you know, between two great Chipotles there's a market where we might not want to have entered just because there wasn't a new development that we thought was going to drive very, very high sales volume.

But now we believe we can be very confident in going into situations that have lower sales volumes and still have a very high return on investment.

Now, keep in mind that when any of us - Steve, Jack or me - are talking about lower sales volumes, we mean sales volumes that are at or above the average store sales of our major competitors. So these aren't low sales volume stores.

And, frankly, we sort of got tired of talking about them as being our lower performing stores because we realized that there's plenty of sales in those restaurants for them to deliver a great return, but because of the fact that we had developed so many restaurants with extraordinary sales levels we'd sort of gotten our unit economic model perfected, if you will, or very, very efficient at those high sales volumes. And we realize now that there's an opportunity, and that opportunity is to go in and really focus on making the lower volume openings very, very efficient so that the unit economics of those is also exceptional.

And that's what's allowed us to maintain our growth from an absolute level unit level, although I understand it's decreasing as a percentage. But we really don't target a certain percentage of growth in terms of new restaurants every year; that's just not the way we do it. We grow as fast as we can find great real estate, as fast as our managers and crews in the field are developing so that we can hand these new restaurants to a very, very competent crew and as long as we can produce a great unit economic story. And with this A Model approach we think we can do all of those things.


Your next question comes from Unidentified Analyst – Stephens, Inc.

Unidentified Analyst – Stephens, Inc.

I just wanted to see if you wouldn't mind elaborating on what you learned in the first menu test and how that's been implemented in the new, expanded test that you talked about earlier in the call.

Steve Ells

Sure. Well, of all the things that we've tried, we realized that the big opportunity is the kid's menu. And I guess what's really exciting about the kid's menu is, well, it brings in lots of kids and families, but really it's very easy to implement because there's really nothing new on the menu. It's simply putting a kid's choices of different things onto a special tray that's compartmentalized, just the way kids like to eat it.

And it's really cool, you know? I see kids going through the line with their parents. Their parents will hold them up and they're pointing at the different things and helping to serve themselves, and it's a really great way for kids to interact and learn the Chipotle system and learn about choosing the kinds of foods that they like to eat.

So we're expanding this to another handful of cities, and if it does well - which we expect it will - we'll continue to expand it.

But I think the big news here is that, while it's a new item, if you will, in that we hadn't had it before, there's nothing really that you have to add because it's just using our existing ingredients. So it's very, very efficient.

Unidentified Analyst - Stephens, Inc.

It sounded as though the smaller or the lower priced items weren't getting as much usage as you might have expected. Have you seen more impact just from the presentation or language that you used on the menu boards rather than lowering or offering more variability in the price points?

Steve Ells

I think that, if I'm understanding you, I think that's the answer. I think that people saw the message that we have lower priced items, but I think maybe people just saw a message, a Chipotle message, which drove in traffic. Once they were there we noticed that they ordered the regular size burritos or order of tacos or bowls that they normally order, not that they were ordering the smaller things.


And due to time constraints we'll take our final question from Paul Westra - Cowen and Company.

Paul Westra - Cowen and Company

Jack, did you mention anything about the share repurchase plan and where you stand on that?

John R. Hartung

No. Well, we finished the last one, Paul, and so we don't have any current plans. We finished the last one early in the third quarter, and then really turned our focus to getting the share conversion across the finish line. Once we get that done - which we'll go through the mechanics of that, have our shareholder meeting, get that done - we're open to considering another share purchase plan.

I just want to point out that we don't consider ourselves to be a mature company that will just roll from one plan to the next. Anything that we do with a share purchase plan will be done in a very opportunistic way.

The one we just finished earlier this quarter, a $100 million plan, was really opportunistic. We bought at an average price of $54, and it was really a no-brainer. And I think to the extent that we decide we've got excess cash in this environment and think it's prudent to return some of that cash to shareholders, I think we'll do it in a very opportunistic way. But we're certainly open to it.

Paul Westra - Cowen and Company

Obviously, we're all looking forward to the overseas or London opening. What would the plans there be? Would you look to another country first or another location? How swift would you do that once it's open in the second quarter?

Steve Ells

Yes, well, certainly I think the biggest opportunity is, if London opens strong, to start opening more locations in London. But we've also said that we think that going into the top three countries - into the U.K. and Germany and France - would be our strategy. So if everything goes well you would expect that we would go into those locations next.


And with that, this does conclude today's conference call. We'd like to thank everyone for your participation.

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