CHIPOTLE MEXICAN GRILL INC — Call Transcript 2012

Speaker 12: Good afternoon, welcome to the Chipotle Mexican Grill third quarter 2012 earnings call. All participants are now in a listen-only mode. After the speaker's remarks, there will be a question and answer session. At that time, if you'd like to ask a question, please press star, then the number one on your telephone number pad. Should anyone need assistance during the call, please press star zero and an operator will assist you. As a reminder, this conference is being recorded. At this time, I'd like to introduce Chipotle's Director of Investor Relations, Alex Spong. Please go ahead.

Speaker 1: Thank you. Hello everyone, welcome to our call today. By now, you should have access to our earnings announcement released this afternoon for the third quarter of 2012. It may also be found on the website 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 as defined in the securities laws. These forward-looking statements will include projections of new restaurant openings, comp restaurant sales increases, the timing and impact of potential menu price increases, trends in food costs, other expense items, effective tax rates, stock repurchase, and our unit economics and investment returns, as well as other statements of our expectations and plans. These statements are based on information available to us today, 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 as updated in our subsequent Form 10-Q for a discussion of these risks. I'd like to remind everyone that we've adopted a self-imposed quiet period restricting communications with investors during that period. The quiet period begins on the first day of the last month of each fiscal quarter and continues until the next earnings call. For the fourth quarter, it will begin December 1st and continue through our fourth quarter release in January. On the call with us today are Steve Ells, our Chairman and Co-Chief Executive Officer, Monty Moran, Co-Chief Executive Officer, and Jack Hartung, Chief Financial Officer. I'll now turn the call over to Steve.

Speaker 14: Thanks, Alex. We're pleased with our results for the third quarter of 2012, particularly in light of continued uncertainty about the overall strength of the U.S. economy. During the quarter, we posted a comp sales increase of 4.8% on revenue of $700.5 million, an increase of 18.4% compared with the third quarter of 2011, adding up to a diluted earnings per share of $2.27 for the quarter. Our results for the third quarter, we remain on pace to meet or exceed the guidance we provided at the beginning of the year in every area. Specifically, we're confident that for the full year, we will see mid-single-digit same-store sales growth and that we will meet or exceed 165 new restaurant openings before the end of the year at the high end of our previously announced range. The performance of our business is driven essentially by two things: our unique food culture, where we look for the best ingredients from more sustainably raised sources and push ourselves to find better ways to prepare the food that we serve, and our unique people culture, where we identify top-performing employees and develop them to be the future leaders of our company. We continue to make significant progress in each of these areas, and our relentless focus on them is what drives the performance of our business. During the third quarter, we hosted our All Managers Conference in Las Vegas. This event brought together an extraordinary group of over 2,000 of our folks, including restaurateurs, restaurant managers, field leaders, and regional and corporate support teams, to share details about our vision, to share programs to help our managers run our restaurants even better, and to inspire and coach our managers to hire and develop a strong bench of future leaders. What always strikes me the most when I spend time with our managers, and particularly spending time with all of them at once, is the remarkable talent, passion, and commitment that exists within our ranks. It serves as a stark reminder of the leadership we're developing and gives me great optimism that Chipotle's best years are yet to come. Our food culture and our commitment to finding better ingredients and better ways to prepare the food we serve has always been one of the things that has made Chipotle different from other restaurants. We continue to push ourselves in both of these areas. During the quarter, we continued to expand our use of sunflower oil to cook our tortilla chips and taco shells instead of the soybean oil we had been using. Not only do we think sunflower oil makes our food taste better, but it also is GMO-free. With California's Proposition 37 on the ballot, the subject of GMOs is becoming a bigger part of the conversation about food-related issues, and we're pleased to be ahead of the curve looking for non-GMO options to replace the ingredients we use that are genetically modified. Sunflower oil is now used in all of our restaurants except our central region. We expect to have it rolled out there in the coming months. For other foods where we use soybean oil, we're testing a GMO-free rice bran oil in all of our restaurants in New York City and are encouraged by how those tests are working. If all goes well with that, we will look to expand the use of this oil, eventually allowing us to replace the soybean oil entirely. As we move into the fall, our local produce program is coming largely to an end as most of the country enjoys a growing season that spans from June through October. That program has exceeded our expectations this year as we have used more than 14.5 million pounds of produce from local farms, including romaine lettuce, red onions, jalapeno peppers, green bell peppers, and oregano, greatly exceeding our goal of serving 10 million pounds of local produce. We believe that the use of locally grown produce is the right decision for us in that it not only tastes better, but also supports local farming communities around the country and is consistent with our commitment to working with independent family farms whenever we can. Helping people understand how our ingredients are raised and how they are prepared continues to be a dominant theme in our marketing this quarter. Since the end of last quarter, our local marketing team has held more than 70 events nationwide, including two of our signature Cultivate food and music festivals. In total, these events reached more than 1 million people with messages about our food and our commitment to cultivating a better world. In particular, our Cultivate festivals, this year held in Chicago and Denver, attracted more than 40,000 attendees, and the feedback was overwhelmingly positive. These day-long festivals bring together some of the nation's best celebrity chefs, local farmers, and popular bands for a celebration of Chipotle's commitment to great-tasting, responsibly raised food. This year, along with a variety of special Chipotle menu items, we served select items from our ShopHouse menu at both Cultivate events. ShopHouse proved to be an incredibly popular event with long lines and rave reviews from customers throughout the day. In addition to our ongoing local marketing efforts, we are once again preparing for our annual Boorito Halloween promotion. Last year, hundreds of thousands of people came to Chipotle dressed in family farm-themed costumes to help raise $1 million for the Chipotle Cultivate Foundation. This year, we're broadening the appeal of the promotion by extending our offer of $2 burritos to people dressed in any type of costume. This Halloween, between 4:00 P.M. and closing, people dressed in costumes can get a burrito, bowl, tacos, or a salad for only $2. Proceeds of up to $1 million will benefit the Chipotle Cultivate Foundation. While Chipotle in the U.S. continues to be the focus of our growth strategy, we continue to explore the prospects for Chipotle in international markets as well. Before the end of the year, we plan to open our first restaurant in Vancouver, Canada, and we hope to open in Germany sometime later next year. Our other growth option, ShopHouse in Washington, D.C., continues to perform well, and ShopHouse was a big draw at both Cultivate events. In fact, when I see how people are responding to ShopHouse, it reminds me very much of the reaction I saw when I opened the first Chipotle. We think it's time to introduce ShopHouse to another market and plan to open the first ShopHouse in Los Angeles in the first half of 2013. Like Washington, D.C., we think Los Angeles will be a great market for ShopHouse. It's a tremendous food city with a variety of international influences, and we think ShopHouse will do well there. Our first L.A. location will be in Santa Monica. In the meantime, the second ShopHouse location in Washington, D.C., is under construction and should also open early in 2013. While we are certainly encouraged by the growth potential for Chipotle outside of the United States and for ShopHouse, it's important to remember that building the Chipotle business in the United States will be the primary driver of our growth for the foreseeable future. Our commitments to improving our food culture and our people culture have never been stronger, and our business results demonstrate the benefits of our unwavering focus in these critical areas. This focus will not only allow us to achieve our vision to change the way people think about and eat fast food, but it will also allow us to deliver strong business results in the years to come. I will now turn the call over to Monty.

Speaker 10: Thanks, Steve. Our All Managers Conference last month in Las Vegas was an amazing time. Every other year, we hold this event to gather all of our managers and field leaders together to discuss how we can best achieve our ongoing vision of creating an amazing food culture and people culture in this company. It was the third time we've held this event, and the feedback from our restaurant teams is that this was the most effective and impactful event we've ever had. The talent of our people, their enthusiasm, and their optimism for their future and the future of Chipotle was truly inspiring. In addition to our managers and field leaders, most people from our headquarters and field offices attended the conference this year, as well as our board of directors, and it seems that all of them were amazed by the incredible managers we have and their optimism and exuberance about the future of our company and the opportunities that exist for them and their crews at Chipotle. After returning from the conference and after visiting a number of restaurants, I'm already seeing that the conference has had a profound impact, not just on the managers who attended, but on the entire restaurant team. Each crew member I see can't wait to tell me how their GM came back more inspired and energized than ever, and they tell me how inspired and motivated they are to create Restaurateur cultures in all of our restaurants. Most of the crew tell me with confidence that they will become a GM or Restaurateur before the next conference, and that they're excited to be part of this magical gathering that their GM has described to them. The conference is designed for our managers, and it's intended to share a clear vision with them that they can bring back to their teams to give them inspiration and direction for their continued advancement, and to make sure that they are aware of the excellent support available to them and their teams from our corporate staff. Managers leave with new information to help them do all facets of their job better, inspired by a vision and with a clear understanding of their role in achieving it. The rest of us leave inspired by the extraordinary passion and commitment we see among our managers and with greater confidence in our belief that we really are developing amazing future leaders for Chipotle. It's truly a remarkable display of the power of the culture we're creating, a culture of top performers who are empowered to achieve high standards. During the quarter, we interviewed 46 Restaurateur candidates and selected 41 to become Restaurateurs, the highest selection rate we've ever had, and a reflection that our culture is building still more momentum. Year-to-date, we promoted 131 new Restaurateurs out of the 153 candidates that we interviewed. This represents not only more Restaurateurs, but also a higher acceptance rate than last year. Two-thirds of our restaurants are now overseen either directly by a Restaurateur or by a field leader who ascended from a Restaurateur position. The improving rates of acceptance in the Restaurateur program suggest that our field leadership teams are getting better at identifying the qualities that make a Restaurateur, and also that the quality of managers vying for this elite position is improving all the time. Because this is the engine that drives our leadership development, we are encouraged by the acceleration of leaders getting into the program, especially since our standards are getting higher all the time. In addition to the newly added Restaurateurs, we also newly expanded the roles of 69 Restaurateurs during the quarter, allowing them to begin mentoring and leading other GMs to reach the level of Restaurateur, thereby dramatically strengthening our field leadership teams. Of course, these extraordinary leaders create fantastic dining experiences. They provide exceptional customer service, cook delicious food, run sparkling clean restaurants, and deliver better business results. It should be no surprise that we're seeing these top-performing managers and crews delivering better throughput as well. As you know, about a year ago, we began focusing on relearning and mastering the principles of great throughput because we knew that this was an area where we could provide an even better customer experience. In 2012, that effort has paid off as we've been able to grow the peak lunch hour comp faster than during the rest of the day. That trend continued in the third quarter, where we grew the 12:00 to 1:00 P.M., in other words, peak lunch hour transaction comp, faster than the overall transaction comp, and on average, added an additional four transactions during the peak lunch hour. In the quarter, we also saw our peak dinner hour transaction comp increase faster than the overall transaction comp. In summary, we're pleased with the progress we've made this year in growing the peak lunch hour and peak dinner hour faster than the all-day comp, and we know that with continued focus in this area, our throughput can be even faster and therefore our customer service even better. Moving to real estate, we're pleased to report that we expect to hit or exceed the high end of the store opening guidance that we established at the beginning of this year of 155 to 165 new restaurants. The outlook for our ability to develop new restaurants in 2013 is very promising as well. Specifically, due to the strength of our real estate pipeline, we estimate that we're going to open between 165 up to 180 new restaurants in 2013. In 2012, A Model locations are going to account for approximately 20% of our new restaurants, and we expect about the same percentage of A Models next year. For 2013, we expect to see an increase in the number of restaurants opening in new developments with about 43% of our new locations in new developments next year compared with 33% this year, which is an encouraging sign that developers are becoming more active again. Of our 2013 openings, about 70% are going to be improvement in established markets, with the remaining 30% in new and developing markets. Very similar to the mix that we had this year, but more new and developing markets than we saw in 2011. This balanced approach to managing our portfolio allows us to invest in restaurants with expectations of generating high returns while also introducing or growing the Chipotle brand in new and developing markets. With stronger food and people cultures than we've ever had, better tools to help our managers work more efficiently, and continued emphasis on improving the restaurant experience, along with the strength of our unique economic model, we believe we are well-positioned to provide consistently strong business results into the future. I'll now turn the call over to Jack.

Speaker 4: Thanks, Monty. Overall, we're pleased with our third quarter results against a backdrop of moderate and uncertain economic growth. Transaction trends remained stable from the second quarter. We were able to expand our restaurant level margins over last year. We were also able to generate excellent 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 excellent job delivering great customer service while developing certain future leaders. Our same store sales were up 4.8% in the third quarter, and our average sales volumes for restaurants that have been open for at least 12 months is over $2.1 million. Overall sales for the quarter increased 18.4% to $700.5 million, driven by new restaurant openings and a comp of 4.8%. Year-to-date sales were over $2 billion, an increase of 21.5%. The quarter comp was driven primarily by increased customer traffic, along with a 1.2% increase in prices, primarily from the menu price increase taken in the first quarter on the West Coast. Our average check was lower than expected by about 60 basis points due to selling slightly fewer drinks and a slight decline in the relative mix of our larger iPhone, online, and fax orders. Our to-go orders are higher this year than last year, which may contribute to the fewer drinks sold. A more cautious consumer may also be a factor in both selling of fewer drinks and the reduction in these larger iPhone, online, and fax orders. Overall, our underlying transactions remained about the same as in Q2. Year-to-date comps were 8.3%, primarily driven by increased traffic, while menu price increases accounted for about 3.5% of the increase. October underlying transaction trends so far are similar to Q2 and Q3. Keep in mind, the final 30 basis points of pricing related to last year's increase will roll off, and our two-year comparison is more difficult by 100 basis points as we compare to a two-year comp of 23.7% in Q4 versus a 22.7% comparison in Q3. Unseasonably warm weather last December is contributing to the tougher comparison. Q4 comps are expected to be lower than Q3. Overall for the year, we reconfirm our full-year sales comp guidance of mid-single digits for 2012. As we look to 2013, we expect comps in the flat to low single-digit range, excluding the impact of any future menu price increases. We don't have any specific plans to increase menu prices next year, with inflationary expectations related to the summer drought looming, which I'll talk about later, we remain open to the possibility of a price increase next year. We opened 36 new restaurants in the quarter, bringing our year-to-date openings to 123, and total company-wide restaurants to 1,350 at the end of Q3, which includes one ShopHouse, five restaurants in London, four in Toronto, and one in Paris. We expect to end the year with total new restaurant openings at or above the high end of our 155 to 165 opening range, with A Models representing about 20% of that total. We're also pleased to announce that for 2013, we expect to increase our new restaurant openings to range of between 165 and 180 new restaurants. Our new restaurants continue to perform very well, opening up with sales at the top of or above our communicated range of $1.5 million-$1.6 million. Our unit economics for existing restaurants is the strongest they've ever been, with average volumes over $2.1 million and with industry-leading margins, despite some uncertainty in the current economic environment. Diluted earnings per share for the quarter was $2.27, an increase of 19.5%. This includes about $1 million for bad debt expense related to general contractors who became insolvent before paying their subcontractors. We were able to grow EPS at a slightly faster rate than sales, as we delivered strong sales leverage in every line item except for G&A, which included about $5.5 million for our All Managers Conference in September. Our operating margins were up 20 basis points, while restaurant level margins were up 70 basis points compared to last year. Year-to-date, diluted EPS was $6.80, an increase of 37.1% over last year. Again, efficiencies from higher comps allowed us to leverage every line item on the P&L except for G&A, which on a year-to-date basis, was up 20 basis points from last year due to higher non-cash stock comp expense and the All Managers Conference. Restaurant level margins year-to-date were 28%, an increase of 210 basis points. Food costs were 32.6% in the quarter, which is down 50 basis points from last year. Avocado costs continue to be favorable due to a strong harvest and good supply availability. Lower cost for avocados and cheese more than offset continued rising prices for chicken, steak, and rice on a year-over-year basis. Excluding the impact of menu price increases, our underlying food costs are up about 2.5% this year, which is better than what we expected at the beginning of the year. On a sequential basis, moving from Q3 to Q4, we expect food inflation in the low single digits, driven by higher dairy and meat prices, resulting from higher feed and corn prices as a result of this summer's drought. As we look to 2013, we expect continued food inflation on top of inflation we expect to see in Q4 in the low single digits, as the impact from the drought continues to be felt from the weaker corn harvest, higher corn prices, which will result in higher meat and dairy costs next year. This expected inflation would be higher, except that we're hopeful that avocado prices in 2013 will remain about the same as this year. The unusually mild weather patterns this past spring have created conditions favorable for a larger avocado crop, which should result in a strong harvest next year. The combined inflation in Q4 and next year is expected to be in about the mid-single digit range. Should that kind of inflation materialize, we will consider a price increase to help offset the impact. The timing of any price increase will take into account a number of factors, including the actual realized food inflation, our transaction trends, general consumer confidence in spending trends, and the competitive response to inflation. In this still uncertain economic environment, we will be patient and thoughtful about the timing and magnitude of any price increase. Labor costs were 23.2% of sales in the quarter, a decrease of 10 basis points from last year. Labor leverage was driven by the positive transaction comps along with the menu price increase. Year-to-date, labor costs are down 60 basis points. Occupancy costs for the quarter declined 10 basis points from last year, 30 basis points year-to-date, due to higher average restaurant sales. Other operating costs were 10.5% for the quarter, a decline of 20 basis points. Year-to-date, other operating costs were 10.2%, down 70 basis points from last year. Favorable sales leverage in the quarter was partially offset by higher marketing expenses. Marketing costs were 1.4% in the quarter, up 30 basis points from last year. Year-to-date were 1.1%, or down 20 basis points from last year. We expect marketing to increase in the fourth quarter to around 1.7%, and our overall marketing will be about 1.4% for the full year in 2012, and should be about the same in 2013. G&A was 6.9% in the quarter, 60 basis points higher than last year. The increase was due to our biennial All Managers Conference, along with non-cash, non-economic stock comp expense of nearly $14.5 million in the quarter, and nearly $52 million for the year. This is $3.8 million higher in the quarter, and $19.6 million higher for the year compared to last year as a result of stock options issued at a much higher stock price. As mentioned earlier, we also had about $1 million in bad debt expense in the quarter for general contractors who became insolvent before paying their subcontractors. G&A in the fourth quarter will include $1 million related to our Boorito promotion and fundraising event, which will benefit the Chipotle Cultivate Foundation. In 2013, we expect G&A as a percent of sales to be about the same as in 2012. While G&A next year will benefit by not having expense of our All Manager Meeting, that benefit will be offset by wage inflation and a higher non-cash stock comp expense. Of course, the stock comp expense will depend on the stock price at the time options are granted, but assuming a similar number of options granted at a stock price similar to what we've traded for recently, we estimate the related accounting expense will be in the range of $70 million-$75 million, compared to about $68 million this year. We expect our effective tax rate for both 2012 and 2013 will be about 39%. We're now $88 million into our $100 million stock repurchase program through today. Over the past four years, we've purchased a total of $388 million of Chipotle stock at an overall average share price of $117. As we're nearing the end of our $100 million repurchase, our board of directors recently approved the investment of an additional $100 million into Chipotle stock. While we continue to generate more cash from operations than we invest in the Chipotle business today, we're confident that the growth options we are seeding today, including ShopHouse and Chipotle outside the U.S., will provide attractive value-enhancing growth investments in the future. In the meantime, we'll continue to invest in our high-returning domestic restaurants, and we'll continue to opportunistically repurchase our stock to enhance shareholder value. Thanks for your time today. At this time, we'd be happy to answer any questions you may have. Operator, please open the lines.

Speaker 12: Thank you. At this time, if you have a question, please signal us by pressing 1 on your touch-tone telephone. Also, if you pressed 1 earlier in today's request with Deutsche Bank.

Speaker 5: Yeah, thanks, guys. Can you hear me okay?

Speaker 12: Again, that is one.

Speaker 4: Yes.

Speaker 14: Yep.

Speaker 5: Okay, great. Jack, you went through a lot quickly there, Jack, I just want to follow up on the commentary around the pricing versus inflation for next year. First on the pricing, can you say if you guys are testing anything right now and sort of what level you would be testing? Then on the inflation, just want to confirm the year-over-year inflation for next year on the food side, did you say it was mid-single digits? If you could clarify, thanks.

Speaker 4: Yeah, sure. Jason, we are not testing any menu price increase right now. What we want to convey is that it looks like inflation is upon us. The effects of the drought from this summer is going to impact us. It is already starting to impact us in October. We expect to see higher prices overall in the low single-digit range, moving from the third quarter to the fourth quarter. Then on top of that quarter, we expect to see continued effects from the drought. The effects are going to be seen in higher dairy prices and higher meat prices. We think that is going to add another low single-digit amount on top of the fourth quarter. Overall, when you look from where we are right now into next year, this 32.6% food cost that we saw in the third quarter, into next year, we are seeing somewhere when you add what we expect to see in the fourth quarter and into next year, somewhere in the range of a mid-single digit inflation rate. Then in terms of the price increase, Jason, we really want to see how things play out in terms of the economy, in terms of our transaction trends, in terms of actual inflation, and in terms of what competitors do and how customers respond. Once we have all that information, then we will decide whether and the magnitude and timing of what kind of price increase we might implement to help us offset some of this inflation.

Speaker 5: Just to follow up on that, how quickly could you guys move on pricing? I don't know what amount of time you would need to test and evaluate the tests. Any historical sort of averages on that?

Speaker 4: Yeah, it doesn't take us that long, Jason, to be honest, but I will tell you, we're going to be patient about it. Let's say we see inflation of a couple of % in the fourth quarter and a couple of % to move into early next year. We're not going to be in a hurry to offset that. We'd rather be patient. We'd rather see what happens with the economy, see what happens with consumer spending, see what other competitors do and how consumers respond. We can move quickly, but we're going to choose to not be in too much of a hurry. We don't want to be the first ones out of the box with trying to cover the effects of inflation. While we can move quickly, I think you'll see us be patient.

Speaker 5: Okay, that's helpful. Thanks.

Speaker 4: Thanks, Jason.

Speaker 12: We'll go next to Nicole Miller with Piper Jaffray.

Speaker 4: Hi, Nicole. You there?

Speaker 12: Ms. Miller, your line is open if you still have a question.

Speaker 11: I'm sorry. I was mute. Can you hear me now?

Speaker 4: Yep.

Speaker 14: Yep. Hi, Nicole.

Speaker 11: Sorry about that. I was on mute, I apologize. Good afternoon. My question was centered around the DNA of the brand, from the genesis to where it is today, because a lot of other brands selling or offering the same cuisine or different want to be like Chipotle. The one thing I've noticed that is different is customization. Do you have any information how important the ability to customize at Chipotle is to your consumer, and as that would differentiate you from other concepts?

Speaker 14: Well, Nicole, I don't know if we have any hard data that speaks to that. I can tell you that when I opened the first restaurant 19 years ago, the initial reaction was that it was a very limited menu offering and the people said, "You can't just have burritos and tacos." What customers soon came to understand was that we focused on just a few core items: chicken, steak, barbacoa, carnitas, beans, fajitas, these kinds of things. It's the ability to combine not only for taste but for diet that keeps people coming back again and again and again. I think that's why you have such a high frequency at Chipotle. It's because of that ability to customize. I think it's extremely important. As we expand the idea of Chipotle into ShopHouse, the exact same idea applies, and that is we focus on making just a few different items for the ShopHouse customers to choose from, their ability to combine things to create different kinds of flavor is pretty vast. We think this idea of focus on a relatively narrow set of offerings, but have it be able to please a bunch of different palates and a bunch of different diets is really important. It also contributes to the success of the economic model. Again, the more streamlined and focused your operation is, the stronger your economic model. This allows us to invest disproportionately relative to our competitors in our raw ingredients. Of course, this makes our food taste better, and it also has a really great Food with Integrity story. It also allows us to invest in our top performers. We think that this customization thing is really important. We do some research into why customers come to Chipotle. Taste is always the number 1 reason why people come, but this customization, as it turns out, is always in the top four items. Very important to our customers.

Speaker 12: Very helpful. Thank you very much.

Speaker 10: Thanks, Nicole.

Speaker 12: Moving next to John Glass with Morgan Stanley.

Speaker 6: Thanks. I wanted to just first start with the comp guidance for this year and next year. This year, mid-single digits. Jack, I appreciate you want to be conservative, you could get to even single digits with negative comps in the fourth quarter. If you plug in a two or three, you get to seven. Seven mid-single digits, or what are you trying to maybe steer us toward in the fourth quarter, more specifically?

Speaker 4: Yeah. John, in essence, we've had that guidance throughout the year, we've just not changed it. I think what is more important to focus on is when you're moving from the third quarter 4.8 to the fourth quarter, the two things that we see that are different between those two is, one, we lose a little bit of menu price. That's about 30 basis points, that's a tougher comparison. When we look at how we've recovered since the recession, we look at two-year comps, it's 100 basis points tougher comparison when we move from Q3 to Q4. Those are the two things that I would take into account in terms of what we'd expect in the fourth quarter. That should give you an idea in the fourth quarter.

Speaker 14: We weren't trying to say that there's any other kind of trend to take into account with that, just reaffirming our annual guidance.

Speaker 6: Okay. Next year, flat to up a little bit. Again, I appreciate the conservatism, but would that assume, in your minds, a negative comp in the first quarter and sort of a normalization in the back half?

Speaker 4: That's more precise, John, than we're able to predict at this time. What it really predicts is that we've seen kind of a leveling off of our transaction trends. We're up about on a three-year basis since the recession is over. We're up in the 26%-27% range. It looks like there's a little bit of slowing of consumer confidence. So when you project that into next year, it looks like it's relatively flat or slightly positive. I would say that trend, John, we would see throughout the year. Now, the only exception to that, and this might be what you're alluding to, is the weather was extraordinary in the first quarter of last year. So if we have a normal winter this year compared to an extraordinarily warm winter next year, that comparison could lead to a negative comp in the first quarter.

Speaker 6: Then just the last question is, last quarter, there was some controversy around new store productivity. There was some fear around the fact that you were hiring some external managers to make up for a gap in your internal management structure. Can you update on those two subjects? Specifically for the third quarter, it sounds like you're still opening in a more normalized basis, new versus existing markets versus last year. But maybe the comparison was trickier last year, maybe more stores in existing markets last year that made it harder, and this quarter it's more normal. If you could comment on just quality of openings this quarter specifically and also that manager issue that you discussed last quarter, and if you, in fact, went ahead with hiring those outside folks.

Speaker 10: Yeah. John, I guess I'll start with the manager part of it. I think there was some misunderstanding from my comments last time because we've said for years how we hire the vast majority of our general managers from inside the company, and in fact, that number is still 98%. Roughly five out of five managers we hire come from the inside, where that number used to be two out of five several years ago. So that's still happening, and we've got wonderful momentum of being able to train crew people into kitchen manager roles, then service manager roles, then apprentice roles, and ultimately into general management roles. That's going wonderfully well. When I made the comment last quarter about sort of hiring some people from the outside, it was a very narrow focus of hiring just a few area managers. These are folks who will oversee sort of the eight to 15 restaurant range. But hiring some area managers. The reason we were doing that, and we have done that, by the way, we've interviewed, well, we looked at a great deal of resumes and picked just a few of the very top candidates, so we hired a half dozen of these area managers already. The purpose for doing that was simply to allow us to make sure that we are not overstretching some of the terrific field leaders who have come up from within our ranks. We have a tremendous amount of upward mobility through the ranks right now. We have, in fact, area managers, which used to be all of our mid-management leaders used to be called area managers. We have only 25 of those left, and we have 33 of what we call team leaders, who are folks who have either come up from Restaurateur or who are folks who have become team leaders by virtue of developing four Restaurateurs. We also have 37 apprentice team leaders, and these are folks all of whom have come up from Restaurateur positions. The vast majority of our leadership in the field is already folks who have come up from Restaurateur ranks, and usually folks who have come up from crew to Restaurateur and then beyond. The amount of field leaders we have coming from within is extraordinary, and we're very pleased with it. However, there's a few parts in the country, a few places in the country where the folks coming up through the ranks were asked to oversee a lot of restaurants. People who had overseen four were quickly raised to where they're overseeing as many as 20 or 30, and in one case, 40 restaurants. We want to be careful not to overstretch new leaders because we want them to continue to lead the restaurants in a way that is what we believe is most effective, which is creating teams of top performers who are empowered to achieve very high standards. If you stretch people too far, what happens is they tend to start getting a little overly busy where they're going around essentially swatting away at symptoms in the restaurants and not really able to diagnose and correct the underlying problem, which is that the team is not excellent in some of those stores. What we did is we've hired some area managers to make it so we don't overstretch a few of those field leaders. I brought it up last quarter because it's something that we keep a very close eye on, and I wanted to express it to you all. We're talking about a half dozen people we've hired. We'll hire a few more too, opportunistically as needed. With regard to the new store openings, we're very pleased with our new store opening volumes. These new store openings continue to open at or above the $1.5 million-$1.6 million range that Jack has mentioned to you many times in the past. What's also important to note with our new store openings is that these new stores out-comp the rest of the first field. Within a few years, these restaurants are approaching our average store volumes, which have tremendously strong unit economics and great returns. When we look at the mix this year versus last year, we do have more developing markets, but those are doing better than ever. This year, like I said, this year and next year, we're something like 70% proven markets and 30% new and developing markets. Those developing markets, which we used to say to you were in that sort of $1.1 million, $1.2 million range at opening, are now opening much, much better at that sort of $1.4 million-$1.5 million range. That allows us to feel good and responsible about shifting some of our portfolio to that developing market range. Finally, with regard to A Models, like I said earlier, about 20% of the restaurants we plan to open are A Models, and those restaurants, which have lower development costs, are showing wonderful returns as well. Even though the volumes of those restaurants aren't as high as the traditional Chipotles we open, they're high enough to deliver a very, very high return, equal or better than the return of our traditional stores when you take into account the lower development cost. We feel very good about our new store openings. The portfolio is strong. It's been strong throughout the year, and we have confidence that we'll remain very strong in 2013.

Speaker 4: Thank you.

Speaker 10: Thank you, John.

Speaker 12: We'll go next to Alvin Concepcion with Citi.

Speaker 2: Hi, thank you. I just wanted to follow up on the guidance for 2013. I mean, looking back at the last three years, when you provided guidance at this point in time, it's either been low single digits or flat for the following year, and you've significantly outperformed each year. It appears there has been a bit of conservatism in your approach to providing guidance at this point in the year. Is your approach to providing guidance for 2013 any different than it has been in the past?

Speaker 4: It's not any different, but what's different with our comp guidance and what other companies might do is we don't have limited time promotions or games or things where we can say, "Okay, we're going to advertise in some way where we can temporarily bring customers in, and that's going to have some kind of impact on the comp." Every year, what we do is we take our current sales trends, and we push them out into next year and assume that the trends don't get any better and don't get any worse. Very often, just the way the math is going to work, you're often going to end up in a range that's in the guidance range that we always give, which is in the low single digit. This year, we're giving it in the flat to low single digit. It's incumbent upon us to now find a way to try to change that trend line. If the trend line doesn't change, we're going to hit our guidance. If the trend line gets worse, we're going to fall short of our guidance. If we can invite more customers in, if we can delight more customers, let's say, visit more often and bring friends, if we get some help from the economy, we'll be able to beat that comp guidance. In terms of the math exercise we go through each year, and the way we figure out what the guidance should be, the math exercise that we go through is the same each year.

Speaker 2: Great. Thanks. I wonder if you could comment on how you believe your market share held up this quarter versus last quarter, given some recent concerns about competition. In light of some competition at lower prices, what is your level of comfort with the current menu offerings and price point ranges at this point?

Speaker 4: I'll comment on the sales trends, and Steve may want to comment about the menu. We're pleased with our transaction trends. We still don't think the economy is in great shape. We still think consumers seem to be a little bit cautious right now. There was a lot of noise during the quarter about somebody taking market share away from us. They did a lot of very heavy advertising. A lot of the advertising was intended to attract our customers for obvious reasons. Our transaction trends in the second quarter, when none of that advertising happened, were identical to the third quarter when there was very heavy advertising during the quarter. We're not seeing any kind of loss whatsoever in our transactions moving from us to any other competitor. Having said that, it was the same Q2 to Q3. We'd love to see more customers coming in. We're going to do everything we can to make sure that we're focused on continuing to hire top performers, continuing to improve the taste and the quality of our food, continuing to improve the dining experience at Chipotle, and hope that more To our customers will decide to visit Chipotle or existing customers will decide to visit more often. I don't know, Steve, you want to say something about the?

Speaker 14: Yeah. Could you repeat your question, please?

Speaker 2: Yeah. Given some of the competition, they're promoting at lower prices. What's your level of comfort with your range of offerings in terms of the menu and price points?

Speaker 14: Sure. Well, at Chipotle, we're doing something that's very unique in the world of quick service. That is, we're bringing the elements of a real dining experience. On the kitchen side of that means we're buying really great raw ingredients, sustainably raised ingredients. Then preparing those according to classic cooking techniques, serving them in an interactive format so that people get exactly what they want. When I say interactive format, people go along the service line and pick and choose exactly what they want and how much of it they get. It's really sort of unique to the world of fast food, we've had many imitators over the years. People who recognize that there's value in this system, in this new fast food system that we've created. Perhaps some have argued that this is the new fast food. It's actually not a very easy thing to copy. Lots of people copy the veneer. For example, one could try to offer a low-cost item of a Chipotle menu item. Maybe it would only on the surface appear to be similar. When you dig down a little bit deeper, maybe it's very different. If you look at a recent competitor who offered something that maybe looked similar on the surface, it contained, say, grilled chicken, yet that company does not have a grill, nor do they have knives or cutting boards. How do they make grilled chicken and chop it up? When you look down and dig a little bit deeper, you realize that it's almost impossible for them to duplicate what we're doing. I think in the end, the customer can realize the difference. Our customers love what we're doing. We get comments all the time that they appreciate our commitment to really good ingredients so they're able to feed their families really wholesome food. I think this is not a trend that's going away anytime soon. I would just say be careful of those who have a lower cost opportunity. Look a little deeper to see what it is that they're really providing.

Speaker 2: Thank you very much.

Speaker 14: The customer's not easily fooled.

Speaker 12: We'll go next to Stephen Anderson with Miller Tabak.

Speaker 13: Yes, good afternoon. Just a question, actually, on your expansion to some of the developing markets, I see you have good penetration in some of the urban and some of the college town markets, as you go more deeper into suburban markets, is drive-thru an option that you've considered? I see some of your competitors in the fast casual space have adopted it. Is this something that you would look into?

Speaker 14: I would never say that we'll never do a drive-thru. In expanding the Chipotle concept as we go to new markets, the question always comes up, "Well, should we try one with a drive-thru?" Part of what customers love is the ability to customize, as I just explained earlier from a question by Nicole, that it's sort of very important to our customers in the top four reasons why they like to come to Chipotle. A drive-thru distances them from that. It doesn't seem like for the majority of our customers, it's something that would be relevant. That being said, it's certainly something that we could try in the future. It's just not something that research about our customers and how we deliver the Chipotle experience, it doesn't lead us to drive-thrus.

Speaker 13: Okay. Thank you.

Speaker 12: We'll hear now from Michael Kelter with Goldman Sachs.

Speaker 9: Hi, guys. I wanted to ask, given the meaningful change in traffic trajectory that you've experienced since May, what strategic or tactical changes, if any, do you now plan to implement to adjust relative to maybe what you were planning before?

Speaker 14: Well, Michael, I think that what we noticed is that when we're really on our game and have a great team of all top performers and are cooking delicious food and providing an extraordinary customer experience, people love it. While perhaps comps are off a little bit, I don't necessarily know that this is a trend, and I would hate for us to do something that's off-brand, something that customers wouldn't see as Chipotle. I think the best way to ensure that we continue to drive the business, to strengthen the brand, to continue to win new customers and get existing customers to come back more and more, is to continue with our Food with Integrity mission, continue to explain to them the importance of sustainably raised food, because that message is getting through. Continuing to refine our marketing. I think last year we had a major breakthrough in connecting with customers on an emotional level that hasn't been seen in marketing in many years with our Back to the Start video. We have plans to do the same kinds of emotional connections, but to add on traffic-driving parts to that marketing. I don't think you'll see any radical differences in what we're doing, but just continue to do the things that we think drive our business, the things that our customers love.

Speaker 9: Maybe another way to talk about this, maybe your future planning sessions, maybe. Looking further out than just a knee-jerk to what's going on in one quarter. Are you considering pursuing new traffic drivers, like new menu items or expanded hours, possibly including breakfast, a step up in traditional advertising? If none of these are in the near-term horizon, which might you pursue, or what other things might you pursue before the others?

Speaker 14: Sure. Well, as we talk in strategic sessions, we've discussed all of those things and more, for sure. One thing that we're all very careful to do is to make sure that we continue to strengthen the brand and do things that support our mission, and to satisfy our customers. Additionally, we want to make sure that we preserve our economic model, because it is a very strong unit economic model that helps drive the things that make us successful in the first place. Making for better service through better people, and making for better food through better ingredients. It is certainly logical to look at things like breakfast. The question is, what would that be? What would those offerings look like? It's certainly logical to look at additional menu items, but what would they be? It was interesting, a few years ago, at the height of the recession, we thought that perhaps we could offer some lower-priced menu items. In a select couple of markets, we did that. What we noticed is people looked at those ads that were promoting the lower-priced menu items and went ahead and ordered their regular menu items, their regular full-price menu items. Customers at Chipotle tend to get the same thing over and over again. They might tweak it here and there and slightly vary it. I don't think our customers are necessarily looking for a radically new menu item. I would lean probably more toward something like breakfast if we were looking at expanding the menu. That also expands the day part. None of these things are off the table by any means. If we do them, we'll certainly do it with the same quality, same attention to detail, and ultimately with the goal of satisfying our core customers in a way that satisfies them during our normal opening times with the normal menu. Layering on opportunities, seeding opportunities like ShopHouse and International are certainly ways to think about potential growth opportunities in the future.

Speaker 9: Thank you very much.

Speaker 14: Thanks, Michael.

Speaker 12: Moving next to Larry Miller with RBC.

Speaker 7: Yes, thanks. I just had two quick ones. Jack, how should I think about restaurant-level margins in 2013 if your guidance is zero to low single digit same-store sales?

Speaker 4: Well, at that level, Larry, with inflation, margins are going to be under pressure. Food costs are going to rise in the fourth quarter. They're going to rise again next year. That all by itself is going to have a negative hit on our margins. When we talked about what it takes, for example, what kind of comp do you need, transaction-driven comp to drive labor leverage, I've always said you need something in that mid-single digit range. You can see that we had, in this quarter, just a little bit of labor leverage when we had a mid-single digit comp. If we have low single digit in our comp and we have inflation, that's going to put pressure on our margins.

Speaker 14: Now, keep in mind, eventually it would be our intent to pass on the higher cost of doing business, especially inflation, through a menu price increase. We're going to be patient at that. I would think of our business in terms of pressure on the margins from inflation, pressure on the margins, assuming that we have this low single-digit comps, and then there will be the opportunity sometime in the future when we decide, okay, the economy seems to be picking up, consumers seem to be confident, others have increased prices, and it looks like it's an okay time to raise prices. We could recover that margin back. Longer term, Larry, our margins as they are today are sustainable. In the short term, I would expect there to be some pressure.

Speaker 7: Okay. That's helpful. How should I think about the $100 million plus share buyback authorizations? Is that something that you'd look to complete in 2013?

Speaker 4: You mean the new one?

Speaker 7: Yeah, the new one. Plus, you have some existing.

Speaker 14: Yeah. It depends on our stock price, Larry. If the stock price remains under pressure, we'll buy a lot more. You may have noticed we bought a lot more in the last quarter than we did in the two quarters before that combined, a lot more. Not that we try to anticipate, or we don't do day trading per se, but we put in place a chart that allows us or results in us buying our stock back a lot more aggressively the lower our price goes. We're much more conservative when the stock price increases. I would not promise that we would finish the new $100 million before the end of the year. It depends on the stock price. You could expect us to be about as aggressive, if not more aggressive, than you've seen in this past quarter.

Speaker 7: Okay, great. If I could slip in just one quick one, actually. That mid-single digit inflation you're talking about for 2013, are you contracted on anything at this point, or how should I think about that?

Speaker 4: Just a few things, Larry. We've got our rice contracted through three quarters. Next year, we've got some of our corn, just a small amount of our corn, not even all of our corn needs. That's about it right now. A very small amount is contracted right now.

Speaker 7: Okay, thanks a lot. Appreciate it.

Speaker 4: Okay. Thanks, Larry.

Speaker 12: Our next question will come from David Tarantino with Robert W. Baird.

Speaker 3: Hi, good afternoon. Jack, first a quick clarification question on the traffic in the quarter, the same store traffic. I think you mentioned there were some negative mix impacts. Maybe could you clarify what the composition of the comp was, traffic mix, and pricing?

Speaker 4: Yeah, David, in the quarter, our comp was 4.8%. We were about 60 basis points off on average check, underlying traffic was about 4.2%.

Speaker 3: Okay, that's helpful.

Speaker 4: Yeah.

Speaker 3: I guess, maybe another clarification. How did you see the trend progress as you moved through the quarter? Was it pretty even across the various months? It seemed like maybe you're running a little softer at the start of the quarter. How should we think about that?

Speaker 4: We were pretty stable, David. Obviously, nothing's a straight line. It bounces around a little bit, but I would say it was pretty stable. We had some trading day impact at the end of August versus September. August was a favorable trading impact at the end of the month. September was a negative. If you look at the weeks throughout the three months, they were relatively consistent. We didn't see anything out of the ordinary in terms of trends. The normal kind of choppiness, I wouldn't say there was a trend where we were soft and then got strong. I would say it was reasonably consistent.

Speaker 3: Okay, thanks. That's helpful. Then one question on the unit economics. Currently, I guess maybe if you could give us an update on what you're seeing on the development cost side year-to-date and what your expectations are going forward. Maybe if you could comment on your expectations for the returns for the new units that you've opened this year relative to recent years.

Speaker 4: We expect our openings this year to average right around that $800,000 that we've seen for the last few years. We hope that it will be similar next year. There is some pressure. Next year, there is some inflation. We're hoping that we'll be able to offset some of that. We're hoping next year that we'll still be in kind of the $800,000 range next year. That might tick up a bit. I don't have anything specific to give you on that. In terms of our openings, when our restaurants open at or above the high end of the range, if you look at a couple of years of comps, our newest restaurants always outcomp the rest of our restaurants. As Monty Moran mentioned, our new restaurants, within a couple of years of comp, can pretty quickly approach our average unit volumes of today, they're $2.1 million. Let's say, just to use a round number, David Tarantino, let's say that within a few years of comp, they're in the $2 million range. You're looking at the kind of margins that we're generating and call it in the mid 20% range, for example. You're talking about a $500,000 cash flow on an $800,000 investment. You're talking about a 60% return, a better than 60% return. That's what we expect with the openings that we're seeing this year.

Speaker 3: Great. That's helpful. Thank you.

Speaker 4: Thanks, David Tarantino.

Speaker 10: Thanks, David Tarantino.

Speaker 12: We'll go now to Matthew DiFrisco with Lazard Capital Markets.

Speaker 8: Thank you. Most of my question's been answered, but except I just wanted to go into sort of looking at the comp and what's been driving the comp the last couple of quarters as far as the throughput initiatives. How should we view that as far as when you now are going to be lapping it soon and you look at into 2013? Is this something that is multi-year and you could build upon, or is it pretty much when you look at the base and you look at the low-hanging fruit and your high volume stores, have we gotten optimization quickly and we've driven the traffic, or is that also something that could be playing into sort of the more conservative guidance going forward, I'm wondering?

Speaker 10: Yeah, I would start by saying it's really not something that's playing into our guidance going forward at all. Throughput, we see it as a key attribute of Chipotle's customer service, and the better our throughput, the better the customer service. When I talk about our throughput improvements and the fact that our lunchtime, that is to say peak lunchtime and peak dinnertime hours having a higher comp than the rest of the day, I don't want you to take from that that means that the throughput drove the comp. Not the overall day's comp, in other words. If you look at it, what happened was our comp during the peak lunch hour, for example, was more than a point higher than our overall comp company-wide. What that shows us is that we're putting more people through at lunchtime, and the same thing was true at dinner. We're putting more people through at dinnertime than before. That's despite the fact that the overall transactions for the day only went up by the amount of our stated comp. If you look at the lunch hour, for example, where I said we did over a point better on our lunchtime comp, we actually cannibalized from the 1:00-2:00 hour in order to do that. In other words, we put people through that might have historically gotten their lunch at 1:01 P.M., we put them through at 12:58 P.M. instead. That allows us to get that comp into the lunch hour. What that means is our crews and restaurant managers are doing a fantastic job of delivering speedier service to our customers. It does not automatically translate into a higher sales comp, we believe over a period of time, it will, because we believe that it's better customer service, number one. Number two, it gives our customers much greater convenience when they come into our restaurants, number two. Over time, people who might have been more afraid of our long lines might get a higher and higher level of trust that when they come to our restaurants during a peak hour, that we'll get them through quickly, and we believe that that will result in comp long term. Faster throughput does not translate into an immediate sales comp increase necessarily. That's something you've got to wait for. Your question is, you asked the question about lapping comps. I'll answer it in terms of throughput comps. Our throughput has been better this year than at any time in our history, that's an accomplishment that we're very proud of. We think we can continue to get faster on throughput because there are restaurants that still have long lines at peak lunch hour, where we're not going nearly as fast as we could. In fact, we think we have a lot of room to get better at throughput, all of our managers and crews are working hard on that right now.

Speaker 8: Along those lines, is there any sort of plan on capital investment or amount of stores that you could target that could put in a second line that also might be something to drive greater throughput that you haven't addressed yet?

Speaker 10: Yeah, we're really not interested in doing that yet, Matthew, just because our ability to increase throughput is so extraordinary. We've got restaurants, our very busiest restaurants during their peak lunch hour that are doing more than 300 transactions per hour every single day like clockwork. Yet we have restaurants that have busy lunches that are down in the sort of 100 range or 120 range that can easily speed up through working with their teams to get better at it. It's much more important for us to focus on the human aspect of it, of getting better and better teams that are focused on throughput than it is for us to throw technology, equipment, or an expensive second make line at the process right now. Throughput is not a limiting factor at any of our restaurants in the sense that we have never shown that we can't go faster in order to accommodate those customers yet. We've never shown that our kitchens and physical facility can't support that greater throughput. We are getting close to our potential in terms of what we're able to accomplish in our restaurants, we wouldn't look to change the physical design of the restaurant at this point.

Speaker 8: Okay. Excellent. Thank you.

Speaker 1: Thanks so much. We're out of time. We've gone slightly over, we appreciate you for joining us today, we look forward to speaking with you next quarter.

Speaker 10: Thanks a lot, everybody.

Speaker 8: Thank you.

Speaker 12: That will conclude today's conference. Thank you all for joining us.