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Chipotle Mexican Grill, Inc. (NYSE:CMG)

Q1 2010 Earnings Call Transcript

April 21, 2010 4:30 pm ET

Executives

Kate Giha – Director, IR

Monty Moran – Co-CEO

Jack Hartung – CFO

Analysts

Jeff Omohundro – Wells Fargo Securities

John Glass – Morgan Stanley

David Tarantino – Robert W. Baird

Nicole Miller – Piper Jaffray

Joe Buckley – Bank of America-Merrill Lynch

Tonya [ph] – William Blair

Matthew DiFrisco – Oppenheimer

Greg Ruedy – Stephens

Jason West – Deutsche Bank

Paul Westra – Cowen & Company

Bryan Elliott – Raymond James

Operator

Good afternoon, everyone, welcome to the Chipotle first quarter 2010 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. Thank you.

And I would now like to introduce Chipotle’s Investor Relations Director, Kate Giha. Please go ahead.

Kate Giha

Thanks so much. Hello everyone, and welcome to our call today. By now you should have access to our earnings announcement released this afternoon for our first quarter 2010. It may also be found on our Web site at chipotle.com in the Investor Relations section.

Before we begin our presentation, I will remind everyone that parts of our discussion today will include forward-looking statements within the meaning of the Securities laws. These forward-looking statements will include discussion of our international expansion plan and A Model restaurant strategy as well as projections of comparable restaurants sales trends, the number of restaurants we intend to open; expected trends and various costs in our business and other statement 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 2009, as updated in our subsequent 10-Q for a discussion of these risks.

I want to remind everyone that we have adopted a self-imposed quiet period, restricting communications with investors during sensitive periods. This quiet period begins on the first day of the last month of each fiscal quarter and continues until the next earnings conference call. For the second quarter, it will begin June 1 and continue until our second quarter release in July.

On the call with us today are Monty Moran, Co-Chief Executive Officer, and Jack Hartung, Chief Financial Officer. Steve Ells, our Founder, Chairman and Co-Chief Executive Officer is traveling out of the country and couldn’t be with us today. So I’ll turn the call right to Monty.

Monty Moran

Thanks, Kate. Steve asked me to pass along a few things in investments so I will start with that. Our performance during the first quarter is something that all of us at Chipotle should be proud of. More importantly, we are proud that during the toughest economic times our entire company remains focus on serving the best foods made from the finest ingredients we can find and providing extraordinary service to each customer visits Chipotle.

And now as the economy appears to be improving those efforts are beginning to pay off with more customers visiting Chipotle more often. And because our restaurant managers and crews are the strongest as they have ever been we are confident each additional visit will be a terrific experience for our customers.

Steve has focused a lot of attention on our first European restaurant which is on track to open in London next month. He personally selected the first restaurant tours who have moved to London and introduced the Chipotle brand there. He also has been active in seeking and finding great local ingredients and is likely to report the food he cooked with these ingredients is delicious.

Steve has used London as an opportunity to take a fresh look at many other things we do in our restaurants including design. We are opening in London with a great site and compelling new design. And we have already started the process of hiring and training a team of top performers. So Steve is excited and optimistic about the opening. And we are confident that this is just the first step in what will eventually become a successful European growth opportunity for Chipotle.

Steve is reporting with Mark Crumpacker, our Chief Marketing Officer on a new ad campaign called Straight Talk, which was launched this month. The new campaign speaks more directly about our food and our commitment to finding more sustainable sources for all of the ingredients we use. But it does in a way that isn’t too serious preachy. It is true to our brand and our personality while addressing a subject that we believe in. And we think our customers are becoming more curious about.

(inaudible) print, outdoor, radio and online. We think this new campaign is the start of deeper, more compelling message to our customers about what we do at Chipotle to serve the best eight things most responsible food we can. We continue to believe that the more our customers know about where the food we serve comes from the more appreciative and loyalty will be to Chipotle.

Shifting gears a bit those of you who have listened to us a lot probably picked up on the fact that we work hard to focus on the few things that we think are the most important to our business. One of these major areas of focus is on building a team and culture of top performers. It’s for that reason that you heard me talk and nearly every night call about this high performing people culture we are building.

Of course, it’s far more difficult to measure and articulate the progress we have made with our culture each quarter that it is for example, to report our comps, our margins or our earnings growth. But it’s clear that this culture and our top performing restaurant teams are a major factor in driving sales growth, strong margins and earnings growth.

Our strategy of hiring only top performers and developing them into a type of leaders while maintaining the discipline to remove low performers has had a dramatic impact. We are preparing a cooking very tasty food providing better customers service and generating better financial results.

Our lead managers, the restaurant tours remain a central element to this high performing culture. During the first quarter we interviewed over 30 excellent managers and from them selected 20 new restaurant tours bringing the total number of restaurant tours to 163. Many of these 163 restaurant tours are mentoring more than one restaurant since that over 300 restaurants are about a third of our current restaurant are now being led by this lead group.

And because of the prestige associated with the restaurant tour position, all of our managers are working to get that. And since they all know the way to achieve that role is to run an amazing restaurant experience and to create a team of high performing crew the influence of the program is literally affecting all of our nearly 1,000 restaurants.

This approach to managing our restaurant allows us to leverage our best leaders increase their influence throughout the company and build better teams. It also allows us to be more confident that we can grow our company successfully. As you know each new restaurant is more likely than ever to open with the strong team in place. This creates the foundation of our company for the coming years as we want all of our future leaders to come from the crew ranks. It is also how we plan to build our culture from the ground out as we enter markets in Europe.

It’s incredibly satisfying for us to see what a high performing empowered team of restaurant managers and crews can accomplish. They hire and develop our future leaders, run great restaurants that are always clean and organized, proudly serve great tasting food made from the very best ingredients, treat our customers to the best service and the best overall dining experience they can and they do all of this while running an efficient and successful business.

To further demonstrate our commitment to developing our managers from within and to give them additional tools to develop their crews to become future leaders we are going to hold our Second Biannual All Managers Conference this summer. This conference will focus on such things as what makes a restaurant tour so that all of our managers know exactly what is expected of them to join this ALLETE Group. It will also demonstrate the importance of our people culture and how our teams of high performers are so important to advancing our food culture and our business model enabled us to do all of these extraordinary things.

We believe that all of our managers better understand how all of these pieces fit together, will help them continue to understand the importance of their role and how that contributes to our overall vision of changing the way people think about and eat fast food.

So of course, we are pleased with our performance. But it’s even more pleasing to note that it’s our special people culture and our teams of top performers that are helping us produce these results. That empowered talent leaders can set the bar even higher than we thought possible.

Now, we are anxious and excited bench of future leaders that are ready to run each new restaurant as it opens. And this special people culture is still growing and providing us with a leadership that will need to keep pace with our growth.

While our people culture and our ability to develop managers is the key factor in our ability to grow so is our ability to find great sites for our restaurant and to find efficiencies in the way we build them. Our A Model strategy is designed to do exactly that. Supplement and improve our development results. And while we were all very confident that the A Model strategy was the right strategy we are even more pleased to report that it’s working.

During the first quarter we opened five A Model restaurants with average development costs well below $700,000 and much lower than our overall average development costs which were about $850,000 last year.

While these restaurants have only been opened in a short time we are very encouraged by their initial sales which despite opening with lower development costs and lower operating costs are on par with traditional new restaurant openings.

Remember, an A Model is a fully functioning restaurant with the same menu and service model. So our customers won’t notice the difference between A Model restaurant and any other Chipotle. These restaurants tend to be a little smaller and the design is a little simpler. And the investment costs, occupancy costs, and operating costs are lower than a traditional Chipotle. But the (inaudible) and the customer experience remain unmistakably Chipotle.

This year we expect 25% of our new openings will be A Model restaurants with all of those being in proven markets. Limiting A Model restaurants to proven markets this year allows us to refine their design and operations with no risk. Ultimately, we also build A Model in new and developing market as well and their lower costs will allow us to generate higher returns at current volume and it will allow us to grow more aggressively in those markets.

Our new A Model strategy gives us another reason to feel very optimistic about our future. And having a culture which continues to attract or retain top performers gives us the comfort that the new restaurants will provide the best customer experience possible. We are confident that we remain on the right path to continue to grow Chipotle and the way it is responsible, both in terms of pursuing our vision and changing the way people think about and eat fast food and increasing shareholder value. And we know we remain focused on these few key drivers of our business are the key to our continued success. I’ll now turn the call over to Jack.

Jack Hartung

Thanks, Monty. We’re extremely pleased with our results for the first quarter and we’re encouraged to see signs that consumer confidence and consumer spending in general, our improving efforts to our consumer environment over the last couple of years. Our restaurant managers and crews work very hard to treasure each customer visit Chipotle during this tough environment and those efforts are paying off as new and existing customers visit Chipotle more often so far this year.

While 2010 is off to a good start we remain cautiously optimistic about remainder of 2010 as unemployment remain high and consumer confidence is not yet back to pre-recession levels. As we entered the recession we remain committed to our vision of changing the way people think about any fast food and strengthening our people culture.

As the economy begins to improve we are more committed than ever to follow the same course. While the effect of economy cause some companies destroy from their strategy we continue to invest in better ingredients, continue to invest in and advance our people culture, continue to invest in bringing the Chipotle experience to more people, by opening profitable, new restaurants. And we did all this while strengthening our business model.

Revenue for the first quarter increased 15.6% to $409.7 million. Revenue growth for the quarter was driven primarily by new restaurants along with a comp sales increase of 4.3%. The comp was driven mainly by increased traffic as we have not had any menu price increase for over a year now. Based on improved traffic trends we are raising our comp guidance from flat to an expected comp increase of mid single digit for the full year.

Diluted EPS for the quarter was $1.19, up 53% from last year. Restaurant level margins were 26.1% for the quarter, up 260 basis points from last year. The efficiencies from comp restaurant sales growth and continue labor efficiencies drove the margin expansion.

As we discussed on the last call we believe our industry leading margins are largely sustainable in 2010. Though they will fluctuate due to factor such as the timing of expenses such as ad spending as well as food inflation.

Food costs for the quarter decreased 80 basis points from last year to 30.2%. The decrease was mainly driven by lower cost for rice, avocados and cheese. We expect food costs to increase slightly during the year primarily in the second half due to modest commodity inflation enabled by increase consumer demand.

Labor improved 100 basis points for the quarter, driven mainly by continued efficiencies and our labor scheduling metrics which is fully implemented in the second quarter of last year. These gains were partially offset by wage rate increases. For the rest of 2010 we expect little or no labor leverage as we fully lapped efficiencies gain from the changes in the metrics starting in the second quarter of last year and as wage inflation creeps in.

For the year, other operating costs were historically and artificially low for us. They decreased 80 basis point from last year to 10.7% fueled by lower promotional and insurance expenses and overall cost containment initiatives. But we spent only 1.1% of revenue on marketing while we expect to spend around 1.8% for the full year. So those all we expect to deleverage this line during the rest of the year as we invest in our new marketing campaign.

G&A decreased 30 basis points from last year to 6.4% of sales. The decrease was the result of the comp sales growth, partially offset by higher stock based compensation. We anticipate no overall G&A leverage in 2010, as we hold our second bi-annual, all managers’ conference in the third quarter, which will add about $3 million to G&A, combined with a 6.5 million increase in our stock comp expense to about $22 million for the full year in 2010.

We opened 20 new restaurants in the quarter for a total of 976 restaurants at quarter-end. Our new restaurants continue to hold up well opening with sales in the $1,350 million to $1.4 million range. We expect to opening 120 to 130 new restaurants in 2010 with about 25% expected to A Model. We still anticipate our 2010 development costs will be around $800,000 with A Model investment expected to be under $700,000.

So with our margins and the comp up the investment down and opening sales holding up well. We are better positioned than ever to add to shareholder value as we open new restaurants.

As a reminder, we began a $100 million share repurchase in November of 2009 and through April 16, we repurchased nearly $30 million with a common stock at an average price of just under $100.

So thanks for your time today. At this time we’d be happy to answer any questions you might have. Operator, please open the lines.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll hear first from Jeff Omohundro with Wells Fargo Securities.

Jeff Omohundro – Wells Fargo Securities

Thank you. I wondered if you could update us on growth productivity initiatives particularly those around throughput at some of your busier markets. You had shared with us in the past some initiatives around hand held and such, I’m just curious you would update us on the progress on throughput. Thank you.

Monty Moran

Jeff, on throughput, to be real blunt I mean we sort of take our eye off the ball a little bit over the last couple of years. We’re having, first, of course, is as we went into the recession, our throughput numbers sell off a little bit and we sort of expected that was appropriate that they should fall off since our transactions were lower than they were before. And especially during the peak lunch hours since that was driven more by the business customer that comes during lunch. So there’s never sell off a little bit. As we looked at it over the last six months or so, basically, what we decided is they sell off a little more than they should have though.

And so we’ve been talking to our teams in the field and our regional directors and we all realize that this is something that we need to continue to put our focus back on. Over the last couple of years we’ve done a great job in scheduling better and making sure we have the right numbers and people working at the right times, but there’s a lot of additional focus that we’re now bringing back to the basic elements of throughput which are having all of our people in their place at the peak hours, making sure that we’re not doing food prep and other tasks that can be accomplished during those peak hours, but instead, we have all hands on deck for the peak hour. So that’s one thing we’re working on.

Another thing is we want to make sure that we have the proper deployment and having exact right people in the right places during the busiest times of day. When I say that we’ve taken our eye off the ball I mean our throughput is not way off, right now, our throughput is about four transactions off per peak hour of where was in 2007 when we were sort of add our best during the busiest times at lunch during the week. But we take that pretty seriously because in most of our restaurants at the peak hour of lunch there is an opportunity to continue to speed up our service and by doing that give better customer service which we believe will add somewhat to our overall comp because we do have some people walking away from the back of aligned again, especially as we get towards our busier times of the year. So it’s a huge area of increased focus right now and I think it is exactly the right time to return our focus that important initiative which beyond helping us financially it’s also one of the key elements of good customer service at Chipotle and something that really sets us apart from our competitors.

Jeff Omohundro – Wells Fargo Securities

Thank you. Congrats on the strong quarter.

Jack Hartung

Thanks very much.

Monty Moran

Thank you.

Operator

And our next question will come from John Glass with Morgan Stanley.

John Glass – Morgan Stanley

Hi, thanks. Jack, I think in the last call, you said, January was off to an okay start, and then February, there was a lot of weather and traffic, I think you had indicated what negative or something to that effect. So can you just trace the progress of comps this quarter given how strong you ended up in the quarter and if you are willing to talk about April that will be helpful as well?

Jack Hartung

John, we did see our transaction turn positive at the end of last year and continued into early January. Weather did interrupt the trend in early February, but we did start to see at the time of our call in February, we did start to see some momentum building at the end of January and in the February but that momentum was interrupted pretty suddenly by the weather. After the call, once the weather subsided we returned to normal weather, we are pleased to see that the momentum continues. So didn’t have the weather I would say. We saw underlying momentum began in late January or early February, picked up again in late February, continued into March, and then holding those levels into April.

So the momentum underlying the weather which was certainly choppy at the time allows us to say the increase our comp guidance for the year to the mid single digit. And we are cautious with that, John, because this is kind of a new bound trend we’re seeing not just in our business but with the consumer, in general. We’re cautious because unemployment is still high and consumer confidence well at higher than was a year ago isn’t quite where it was a couple of years ago, but we’re really pleased with the trend, we love the momentum and while we won’t say what the number is so far into April what we saw in March to continue into April and so we’re pleased about that.

John Glass – Morgan Stanley

Would you be willing to say weather hurt you during the quarter?

Jack Hartung

I think it watched out to not be much of that impact, John, because what happened was once weather subsided we saw some nice strength and then it leveled off from that. And that’s what we have seen at Chipotle. When we had a snow day in a market, we lose a day or we lose a lot of sales in that day. When the weather clears up we actually overperform for a day or (inaudible) it’s almost as if people that weren’t able to visit Chipotle while the weather was bad, kind of make up for that, in some way when the weather improves. I would say it’s enough to something overall for the whole quarter to be not overly material is our take on it.

John Glass – Morgan Stanley

Okay. And then just finally, is the type of commodity inflation that you expect in the back half of the year, is that you think material enough to cause you to rethink pricing or is that manageable in the context of your current price, you’re going to take pricing or need to take pricing in the back half or can you get by without it?

Jack Hartung

I think the food inflation that we’re seeing, John, it seems manageable based on what we know today. We don’t anticipate taking any kind of specific pricing, certainly, not related to the inflation that we see. We’re still thinking food inflation will be somewhere in the low single digit range. I mean that would be in the second half of the year. We do have some plans to try to roll some additional Food With Integrity in certain markets. But even know we’ll probably do that with either no or very modest price increases. So I would expect for the year not to see any benefit from menu price increases for us. Now having said that if things change, if food inflation changes, we certainly have the ability to, but I think we will be patient before we’re rushing the menu price increase that we start to see food inflation.

John Glass – Morgan Stanley

Great, thank you very much.

Jack Hartung

Thanks, John.

Operator

And next we’ll hear from David Tarantino with Robert W. Baird.

David Tarantino – Robert W. Baird

Hi, good afternoon and congratulations on a great quarter.

Jack Hartung

Hi, David, thanks.

Monty Moran

Thank you.

David Tarantino – Robert W. Baird

I have a question about your development outlook. Given that you think you are seeing signs as the economy is improving and you are seeing excellent returns on the A Model strategy are you thinking now that you might look at accelerating the unit growth as you look out into 2011?

Monty Moran

Yes, David, I mean, we always tend to we will grow as fast as we can find great sites and as fast as we can grow. Great teams in order to run those locations. Right now, in terms of development outlook couple of years ago, vast majority, something like 70% of our new restaurants were in a new development. Two years ago, that began to fall off, last year, fell off a great deal as many fewer developments were coming out of the ground, so last year it was even fewer. And now, it’s probably only a third of our new sites that are new developments. I just recently spoke with our Chief Development Officer about this exact issue. Are they seeing any additional sort of pick up in the amount of new developments? And the answer is not yet. And even when we do begin to see that some of these developments are underway, obviously, there is a pretty substantial lead time, probably a year or so, before those begin to materialize.

That being said, we talked a lot about our A Model strategy and the fact that strategy tends to go more into tier two locations and into existing real estate, not as often a new development, although sometimes they are a new development. And that A Model strategy, we’re all feeling very good about it right now, very bullish about it as a way to help us supplement some of the number of locations that we may have lost due to fewer new developments coming out of the ground. So we’re obviously going to keep our eyes open and really work hard to find as many good locations as we can in 2011 and beyond and that works underway now. So we hope to have some good news on that front, but it’s too early to say. Late this year or probably after the third quarter release we will talk to you a little bit about what our plans are for unit growth in 2011.

David Tarantino – Robert W. Baird

Sounds good. And I got just a quick follow-up on that. Is there anything from a human resources or staffing perspective that would give you pause and accelerating the growth rate or is that just a matter of finding the right real estate?

Monty Moran

Right now, we do not believe that that the human resources issue is a limiting factor. Our teams are stronger than ever. I will say that our ratios is in the mid management level, we have about 12 stores per area manager or team leader, whereas five years ago that was six stores per area manager and team leader. It was never our intention to increase that ratio although we did predict that it would increase as we got a team of all high performers in the mid management positions. The restaurant tour growth has been steady. The restaurants tour that we already have are steadily taking on additional stores as they become two or three or four, what we call apprentice team leaders and we’re starting to see more people move towards those positions where they’re already seeing more restaurants.

Those moves, David, really would give us the confidence that we’re going to do with oversee sort of as many restaurants as we can build so long as we continue to produce restaurant tours at the rate that our field teams are telling me that they predict we will be able to continue to grow to add additional restaurant tours. So, the restaurant tour program really is the foundation for how we are going to gain confidence that if we are able to accelerate our unit growth that will be able to run them properly. At this point we do not see that is a limiting factor.

David Tarantino – Robert W. Baird

Makes sense. Thank you.

Jack Hartung

Thanks, David.

Operator

And our next question will come from Nicole Miller with Piper Jaffray.

Nicole Miller – Piper Jaffray

Good afternoon and great quarter.

Jack Hartung

Thanks, Nicole.

Nicole Miller – Piper Jaffray

I just have a little bit about what you’re seeing competition direct or indirect within just the segment, where are you getting this traffic from?

Jack Hartung

It’s a great question, Nicole because it seems like just in reading retail reports from apparel reports and some of the larger retailer and looking at restaurant it seems like almost all the news in the last month or two has been positive. So it looks like that the consumer is outspending, again, it looks like consumer confidence from all the different resources we’ve seen, consumers are more confident today. Dramatically, more confident today than they are especially one year ago. So it seems like people are out, just spending more money and so we kind of feel like we did the best we could while consumers were more timid, about spending money, making sure that they got a great experience every time they visit Chipotle.

That’s we talk about with our restaurant teams all the time is that a consumer is making a very important decision to keep Chipotle as part of their budget when they are spending when times are tough. And we feel like that’s paying off. I don’t know if we’re doing maybe better than average or about average, but generally, consumers are spending. And our experience has been over time when more new customers or existing customers come to Chipotle more often and if we do a great job serving great tasting food in a great environment with great throughput and great customer service that tends to lead to even more confidence. That’s why we’ve had years of very strong comps until it was interrupted by this environment. So in short, generally, the consumer environment seems to be improving and we are taking our fair share of those, those extra dollars.

Nicole Miller – Piper Jaffray

Got you. And then, Monty, I know it’s just going to be one store here in London in May, but could you just touch us a little bit about the store seeing and use of the designs different how and then how big is a team I guess have a regional manager yet or just a GM and who is that team and how does that work?

Monty Moran

The way we’re going to open in London, Nicole, is very, very unusual, although for us it will be consistent with the way we open in Toronto. As you recall, we opened in Toronto couple of years ago and we did that without adding any infrastructure at all. To be specific, we do not have a single employee working in Canada who is not a restaurant employee. And that restaurant has been running the entire time by restaurant tour and he has built a fantastic team and I have gone up there to see the operations in Canada, they have been fantastic. In London, we are going to proceed in much the same way with a restaurant tour opening a restaurant. Although there actually three restaurant tour level employees who are going over to London to open that restaurant. All of them will work in the store for some time but also all of them will participate in helping with sourcing at a higher end training, all of that.

So it’s a little bit more of a broad team over there, but everyone who is going to London is going to be a store level employee. There will be absolutely no “corporate infrastructure.” So that’s very unusual the way we’re opening there, but given how we opened in Toronto we’re confident that that’s exactly the right way to do things to go into London, build a very strong team and use that team to expand in Europe should London prove to be successful and should we be able to find just a location that we’re interested in. And also we mentioned in a call or two ago that Germany and France are sort of on our longer-term radar screen, we’re interested in learning more about proceeding in those countries and that’s another reason why we’re seeing a little bit more talent over to London initially, because one or more of those people would be available to go, help, initiate a new restaurant operation in Germany or France.

In terms of sourcing, our teams have been going over to London for quite some time, Steve has spent a lot of time going over to London and actually visiting a number of different suppliers and distributors. The news that has come back and I have not been part of those trips to suppliers over there, but the news has come back is that Steve has told me that the food that he finds over there is wonderful food. In fact, he thinks it’s going to be easier to find more “Food With Integrity” in the UK than it is here in the States, because it’s such a focus in Europe generally. For instance, here we tell the fact that we have RBGH3 (inaudible) in Europe, there really is no alternative because RBGH is not something that’s acceptable in the dairy supply or RBGH is not used on the animals that are used to produce dairy. So that’s one example, but there is a higher level of awareness about hormones, antibiotics, about local sourcing, that are organic and all that in Europe. So we’re excited that we think sourcing is going to be advantageous to us over there.

Another point though is with regard to sourcing is that we’re going to be cooking everything from scratch in that restaurant. Steve has spent a lot of time with the team over there, making sure that we can cook everything from scratch and so therefore, we do not need to deal with commissaries at all in Europe initially, which means that we’re going to be able to buy even from very small suppliers and it gives us a great deal of flexibility to go exactly where we want, to find exactly the right ingredients to open Europe in a very entrepreneurial way but in a way it’s also very forward on food integrity.

You mentioned design. The design in London, again, Steve approach that as an opportunity to do something new, although it’s not going to be, if you went over there and saw the designs can be very consistent with what our new Chipotle’s look like. And there’s a few of those now in the United States, particularly, couple in New York City that Steve has been very personally involved with. In taking that design Steve worked with an architect in England and kind of approached it from a very new, took a very new look at that and some of those ideas actually came back to the States and became part of what our new design will be here. So, it’s pretty consistent with what our new design in the United States will look like.

Nicole Miller – Piper Jaffray

Thank you.

Monty Moran

You bet, thank you, Nicole.

Operator

And our next question will come from Joe Buckley with Bank of America-Merrill Lynch.

Joe Buckley – Bank of America-Merrill Lynch

Thank you. Couple of questions. On the marketing, Jack, I think you mentioned a full year will be 1.8%. I just wanted to verify that would be the full year spend or will have the kind of spend for the next three quarters. And with respect to the marketing how broad will be, what percentage of store base might you cover and how many markets will you be doing radio in?

Monty Moran

All right, Joe, right now, the marketing is ruling out in basically 30 major markets. There are some of those markets, about half of those where will be a particularly robust sort of integrated campaign, and those markets are the ones where we typically have the greatest density and where it makes the most sense, we’re advertising dollar goes the furthest. I think Jack mentioned in his statement that our marketing for the quarter came in at 1.1%, obviously, that was artificially low and the reason it was is that we’re continuing to develop our new marketing campaign. And of course, that has just ruled out, too early to tell you what its effects are, but it’s pretty clear that we expect our marketing budget to drift upwards substantially so that it will average out sort of to 1.75% for the year and given the fact that the first quarter was 1.1, obviously, that means it will be ahead of those numbers going forward.

Mostly, the marketing so far is radio, outdoor, and bill boards and so forth. The radio did just start playing. And so too early to tell what the effect of that is. And we look forward to tell you more about that next quarter. But the marketing is generally designed to talk a lot about Food With Integrity, going to be different than it’s been in the past, because in the past, we’ve been less direct with those messages in an effort to be sort of revere and fun and not very preachy where we’re still trying not to be preachy but we’re going to make the messages much more clear. Essentially what we’re trying to do is raise the awareness about Food With Integrity but do so by talking also about the thing they’re most concerned about which is taste. I know Steve talked in the last call about this sort of monitor for our marketing plan which was taste good, and the point of that is that we want to tie relationship in our customers’ minds between the very high quality ingredients we are using and how careful we are in sourcing our ingredients. And taste, so we are trying to link those things in the customers mind.

So in essence, what we’re doing is talking about all the things that are important to us like sustainability, environmental stewardship, animal welfare, healthfulness, but doing all of that in a context which makes it clear that our priority and the result is pretty taste. So, we hope that will be effective, we will learn a lot from this and hopefully we will begin to create a still greater volume with our customers as they realize all of things that we’re doing is to change the way the American think about it and hopefully, the world thinks about the need to fast food.

Joe Buckley – Bank of America-Merrill Lynch

Thank you. Could you also give us an update on the kids menu and do you have any newer different thoughts about exploring practice?

Monty Moran

The kids menu practice, yes, right now, with regard to kid menu, during the last call, I told you that that would roll out by the end of the year, we’re still on track to do that. Right now, the kids menu is rolled out in Wisconsin, Denver, Sacramento, Phoenix, Tucson, Utah, most of Texas, Austin, Houston and Dallas and also in Boston. We plan on rolling it to the rest of the country, the next big trench of restaurants that will adopt the kids menu, will take place on or about June 1st and the reason it takes a little bit of time to do that is that very important to train our teams in the field as to how to prepare a kids meal, how to talk about the kids menu and to make sure that we are, from an operational standpoint, excellent at executing a strategy. So this is put on throughput and otherwise negatively impact the operation.

In terms of the effect of the kids menu the kids’ meal was during initial weeks about 2% to 3% of our transaction in the markets that we are in now, but recently it’s trended up more towards 3% to 4% of transactions, without any particular marketing strategy dedicated to it. So, we’re pleased to see that our customers seem to be appreciating, joining and using it more often as also a nice thing because our kids meal do carry with some of much higher ticket average. I guess price something like 70% or 80% higher than our average ticket. Let’s see I had another question I don’t want to forget what it was.

Joe Buckley – Bank of America-Merrill Lynch

With the kids menu do you think some of that business is incremental, can you tell what part it was incremental?

Monty Moran

Joe, that’s really, really tricky to see right now. We’ve looked at it carefully and we just can’t be sure that we can attribute any particular comp increase to the kids menu. The stuff we hear anecdotally from our customers and through our managers will indicate that our customers are very pleased that we have this option, they feel very comfortable or much more comfortable ordering, it makes them feel much more welcome to bring families and so we do think that over time this is going to be a part of a thing for us but I can tell you that we can attribute a certain amount of top growth to it at this point.

With regard to breakfast, Joe, we are still running back just in our Dallas Airport location. We really don’t have a goal of rolling that out anytime soon, we continue to learn from what we are doing in Dallas, and we are just going to watch that for a while. As you know we had to do that at Dallas or I should say we didn’t really have to serve breakfast, but we have to serve food at 7:00 a.m. and so we thought it was a nice time to go ahead and proceed with offering, something a little different, more in the line of a traditional breakfast with some eggs and potatoes and chorizo and so forth. So, we’re pleased with how it's working in Dallas, our customers seem to really enjoy it and we are getting a steady and decent flow of business of breakfast. So we do think it is a possibility in the future it could be a strategy for us but at this point we have a lot of other things to focus on with our current domestic and now international efforts.

Joe Buckley – Bank of America-Merrill Lynch

Okay, thank you.

Monty Moran

Thank you.

Operator

Our next question will come from Sharon Zackfia with William Blair.

Tonya – William Blair

Hello, hi.

Monty Moran

Hi, Sharon

Tonya

Hi, actually, it’s Tonya [ph] for Sharon; I’ve got a quick question. We realize it’s early, but what is your read on the restaurant contribution margin differential between the A Model in the traditional location like 50 basis points, 100 basis points, could you give us an idea?

Jack Hartung

Well it is really early, so I don’t think we could specifically say what the restaurant level margin difference would be. I can tell you if you are talking about a comparable volume like right now we have opened up really similar or the same volume as our traditional restaurants have opened. And if they continue with that, if you compare an A Model restaurant to a traditional non-A Model restaurant at the same volume, A Model will be higher for sure, because it’s got a lower occupancy cost, it’s also got lower operating cost.

Tonya – William Blair

Right.

Jack Hartung

How much lower? Too early to tell at this point. The other thing about A Model is what A Model allows us to do is right now we are only opening up in proven market, but in the future, probably, sometime next year, we will also begin to open these up in some new and developing markets as well. And what’s attractive about that is new developing markets have historically opened up at lower volumes, they have opened up at about a 1 million to 1.1 million and we don’t like the margins that we see with our traditional restaurant in the new developing market and so we don’t open very many restaurants at those sales level.

With A Model we do expect margins and even at the lower volume that may be aren’t just higher there are 26% or mid 20% margins, but somewhere maybe in the 20% range at lower volume. The high teens are 20% range, which based on the much lower investment. We can generate very attractive returns in those. And so either way the A Model at either lower volumes is going to generate higher margins than we got in the lower volumes in new developing markets in the past. And in our proven markets we are opening up at similar sales volumes. We do expect higher margins in A Model but, too early to say exactly what the difference might be.

Tonya – William Blair

Okay, thank you.

Jack Hartung

Thank you.

Operator

And our next question will come from Matthew DiFrisco with Oppenheimer

Matthew DiFrisco – Oppenheimer

Thank you. Just looking at the opening schedule list the 100 to 110, Monty, I think you said in one of the responses to the couple of questions back that the environment still remains I guess you need the pipeline a little longer on this, how do we stand as far the development of that? Is that going to be even throughout the next three quarters or is it going to be somewhat like last year a little back end waited. Then I just wanted to know, can you tell us where the 25% of the A Model in your existing markets where it primarily they will be going in?

Monty Moran

Yes, we said we were over a 120 to 130 this year, obviously, have now opened a 120 of those. The waiting this year will be heavily towards the third quarter and fourth quarter, the back half of the year in terms of when we open our restaurants. The A Models are going to be opening up sort of throughout that time with probably four or so opening next quarter and then sort of a dozen in the Q3 and maybe eight in the Q4 sort of range. And so those will again soon sort of throughout the year with the rest of the opening.

Matthew DiFrisco – Oppenheimer

And what markets for those A’s be going into?

Monty Moran

Well, they are going into proven markets and so our proven markets are the ones where we even conduct businesses for long time and where we got, where we trying to go, get as many sites as we can. And of course, most of our markets are proven markets, most of our development is in proven markets, but those are markets, I mean Denver and DC and Dallas, Houston, Chicago, Phoenix and we are focusing on those markets just to reduce the risk of as we open these we want to open them with the greater chance of success since we are going after tier two locations, obviously, we are meeting with the great deal of success now. It gives us a lot more of a bullish outlook on how this may contribute in the future in the developing in newer markets.

Matthew DiFrisco – Oppenheimer

Okay, and then Jack just last on the marketing expense when the question was the 1.8 you confirmed is for the full year is where you are going to work your way towards as a percentage of sales. Is that the evenly, I didn’t get, it was clear enough that there was evenly going to be expense now for the next three quarters as well or the 2Q also have a couple of weeks where you really didn’t jack it up yet?

Jack Hartung

No, we are going to start it up for sure, starting Q2 and so we can’t commit that it will be even for the last three quarters. Matt, I think it was even, it would be roughly around 2% or so, but we want to remain flexible. We are going to talk to our customers, we’re doing a customer research, find out which of these as really connect we might move some dollars around, we might accelerate on dollars we might defer some dollar. So we want to stay very flexible on that. I think if you are going to just plug something in, I think if you assume it’s relatively even for the last three quarters. I think that’s kind a fair and then as the quarters unfold we’ll tell you more about it, but generally, we need to spend an average of about 2% for the rest of the year and we will spend probably in that ballpark for each of the last three quarters.

Matthew DiFrisco – Oppenheimer

Okay, thank you very much.

Jack Hartung

Okay, thanks, Matt.

Operator

(Operator instructions) We will hear next from Greg Ruedy with Stephens.

Greg Ruedy – Stephens

Thanks, good afternoon. In terms of the Q1 results can you talk to average check if the consumer is getting more confident, are you seeing shrink in a tax rates less than how much of that is baked into your new guidance of mid-single digit same-store sales?

Jack Hartung

Yes, thanks, Greg. Check was stable, if anything it was slightly up, a few pennies up, nothing material is reported on that, but the single biggest thing that drove the check to be up a little bit was the group size is a little bigger. Intruding to that is the fact that we have our facts in our online sales have grown as well. So there is more group sales that are driving it. And our fact in our mind sales those are generally the biggest checks that we have. That’s the group of people that are not just holding that are going to get together and order fax in or through online or even through an iPhone, they are going to send their order in. And those are typically somewhere around 80% to 100% higher average check and is more of that. So I think just more people are buying food, ordering food, and more of that business kind of meeting setting so. So, check is up just a little bit, few pennies I would say, and is driven by more of the group size than anything else.

Greg Ruedy – Stephens

Great, that’s helpful. Switching to the advertising, I think, a year ago you rolled out the new menu task and part of the emphasis there was to educate the guests that they can tailor the experience, maybe order a la carte, is any of the new advertising spend this year going to be directed towards that education factors or is still going to really need to be generated by the restaurant tours and the frontline employees?

Monty Moran

Yes, really, it’s really going to be the ladder by a restaurant tours and restaurant employees. We did do that menu task in Denver; in fact it’s still going on where there are sort of a more variety and more dependent, a la carte, single tacos and all that. Their aspect was that we really liked and one of the things that’s falling out is that the kids’ meal is a success. Single Tacos is something that has been very successful. But our trying to organize the ideas in different ways in order to stimulate the customer to make different choices.

People when we interview them really like that and they were appreciative of it, and they felt like we were taking care of them and so forth but the reality is they ordered exactly the same stuff they’ve always ordered and continued to order on trays and not really pick from the a la carte menu. So that part of the menu will not be something we will be rolling out nationally and we are still going to be counting mostly on our restaurant tours and our store level employees to be communicating with our guests to letting them know the kinds of variety that they can have in our restaurant. It’s just very tricky you accomplish on menu to teach those lessons so we are going to continue to do it at store level for sure.

Greg Ruedy – Stephens

Okay, thanks.

Monty Moran

You bet, thank you.

Operator

And we will move next to Jason West with Deutsche Bank

Jason West – Deutsche Bank

Yes, I just one on the commodity side. Can you guys tell us what the inflation or deflation I guess was in the Q1 and you mentioned things are starting to move up a bit? What exactly you’re seeing moving up and what do you have sort of contracted for the year versus kind of dependent more on the spot markets? Thanks.

Jack Hartung

Yes, the inflation 80 basis points, Jason, that’s probably a net some things cost a little more money, many things cost less money, but when you net it all together, that’s probably about a 2.5% inflation, factored inflation in the Q1. We have just a few very small items contracted, like rice, and these are items that are contracted at least two quarters or three quarters, that will include rice, it will include Soya oil, it would include corn two quarters or three quarters and we have also locked in our pricing for the 30th for the full year. And that’s it. And typically, we are not able to lock in very much of our ingredients.

The other thing that we have historically locked in has been cheese, and cheese we have now locked in, we have been paying at the spot market. And one of the things we are doing with cheese is we are trying to move our supply to more pasteurized areas and so we are kind of moving towards different co-ops and different farmers that are supplying the milk to make the cheese and salad frame in and so for that reason we have decided not to lock in. And we also felt like the spot market was frankly more attractive and so that led us to continue to work up the spot market as well.

Jason West – Deutsche Bank

And so the Q1 you said inflation of 2.5% or deflation?

Jack Hartung

Deflation, sorry.

Jason West – Deutsche Bank

Deflation? Okay.

Jack Hartung

Yes. Yes.

Jason West – Deutsche Bank

Okay.

Operator

And we will move next to Paul Westra with Cowen & Company.

Paul Westra – Cowen & Company

Great. Good afternoon, everyone.

Jack Hartung

Hi, Paul.

Paul Westra – Cowen & Company

Just quick question can you give us an idea of how broad based the comps kind of recovery has been. Not just geographically, I’m actually also curious about new versus kind of more mature markets and actually more precisely if you could talk a little bit about those classes, kind of open up during the downturn, may be seven or eight, it didn’t quite open up this much, are you seeing maybe the ramp that never happened and delay in occurring now?

Jack Hartung

Yes, Paul, first of all, geographically, the comp is very broad based; we saw a change in trend really across the whole country. I would say the only spot that maybe lagging a bit but it’s picking up nicely as well as Texas, but Texas entered a recession a little later, their employment seem to surge a little later than others but even Texas were seeing a nice conference. So it’s a very, very broad-based across the country. And it’s also returning largely to in terms of the layering, in terms of layering of opening, it’s largely returning to the comp trends that we saw before the recession, meaning, our newest restaurants are comping very healthy and even our oldest markets are still positive.

So when we look at the oldest most mature markets they are slightly positive. You look at the newest restaurants and the newest markets and they are comping at really, really attractive comps. In fact some of these markets that we call developing for quite a while, their comps look really attractive to the point where we’re thinking they may be promoted from developing to proven maybe sooner than we had one thought they done based on resurgent sales so it’s very broad based, it’s very healthy across geography and across the layer of the opening.

Paul Westra – Cowen & Company

Okay, and then a question on the pricing, I assume your mid single digit comp assumes your pricing changes would you contemplate and then what would trigger?

Monty Moran

Yes, that’s right; our comp guidance assumes no incremental menu price increasing.

Paul Westra – Cowen & Company

Okay. I guess the most important question is when you two guys are going to get an Oprah?

Jack Hartung

When are we going to what?

Paul Westra – Cowen & Company

In an Oprah Winfrey and you guys have been?

Monty Moran

(inaudible) you mean?

Jack Hartung

Did you see the first time we were on?

Paul Westra – Cowen & Company

Yes, yes.

Jack Hartung

Okay.

Paul Westra – Cowen & Company

I was a big, big –

Jack Hartung

You know the best thing, Paul, is we have a lot of people visiting our Web site and a lot of people visiting our restaurants that were curious about where the food come from. And so Oprah brought this curiosity to mainstream America. And that’s wonderful, that’s something you can’t do in advertising, but you have such credibility you got, such a large audience that you brought this curiosity to people and people brought that curiosity to a restaurant. And our managers are really well equipped to talk about where our food comes from. And so that was a neat little opportunity for Chipotle (inaudible) and so it seems like fee for any of us again, yes, we are going to hurry up, get on a plane and goes there.

Paul Westra – Cowen & Company

Okay.

Monty Moran

It’s really nice to see that I mean Steve got a chance to get to know Michael Collin much better doing that time too, and obviously, Michael was very impressed with Steve and Steve vision for changing the way the world thinks about needs food and obviously, his sort of endorsement as Steve being one of the pioneers that’s going to change food on that show was something that we felt was a real, was a pretty nice achievement, and a nice moment for us.

Paul Westra – Cowen & Company

Okay, okay, congrats on a great quarter. Talk to you later.

Monty Moran

Thanks.

Operator

We’ll hear next from Bryan Elliott with Raymond James.

Bryan Elliott – Raymond James

Hi, I think the quarter could have been better but –.

Jack Hartung

Bryan should have visited more often.

Bryan Elliott – Raymond James

No, I’m obviously kidding and all my questions have been asked and I’m pleased to but remember what they get out of the (inaudible) passes and back to you.

Jack Hartung

Thanks for your honesty, Bryan.

Operator

And that is all the time we have for questions. I will turn the conference back to our speakers for additional or closing remarks

Kate Giha

Thanks so much for joining us and we look forward to speaking with you next quarter.

Monty Moran

Thanks, everybody.

Jack Hartung

Thanks.

Operator

And that does conclude today’s conference. We do appreciate your participation. Have a great day.

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Source: Chipotle Mexican Grill, Inc. Q1 2010 Earnings Call Transcript
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