奇波雷墨西哥燒烤 (CMG) 2006 Q3 法說會逐字稿

[Starts in progress]...and welcome to the Chipotle Mexican Grill third quarter 2006 earnings conference call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the call over to your host, Mr. Chris Arnold. Please go ahead, sir.

Hello, everyone, and welcome to our call today. By now you should have access to our earnings announcement released this afternoon for the third quarter ended September 30th, 2006. It may also be found on our website at www.chipotle.com in the investor relations section. Before we begin our presentation I need to remind everyone that parts of our discussion today will include forward-looking statements within the meaning of the Securities laws.

These forward-looking statements will include projections of the number of restaurants we intend to open, comp restaurant sales trends, income from operations and other statements of our expectations and plans. These forward-looking statements are based on information available to us as of 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 2005, as updated by the 10-Q we expect to file this week, for a discussion of the risks that could impact our future operating results and financial condition.

On the call with me today is Steven Ells, our Founder, Chairman and CEO. Steve is going to provide some introductory remarks, and then Monty Moran, our President, Chief Operating Officer, will offer additional comments about our operations. Jack Hartung, Chief Finance and Development Officer, will then walk you through our financials, development and some general thoughts on our outlook for the rest of this year as well as a preliminary view of 2007. Then we'll open the call for questions.

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

Christopher, thank you very much, and thank you for all joining us today. Before we get into the details of the quarter, I'd like to talk about the separation from McDonald's. As I'm sure you're all aware, McDonald's completed the sale of all of their remaining stock in Chipotle on October 12th through a swap with their existing shareholders. So we're now an independent public company.

I've been asked many times about our relationship with McDonald's and have always answered those questions with the same themes; they were a really good model partner right from the beginning. When I originally approached McDonald's about the possibility of investing in Chipotle, it was a new sort of venture for both of our companies. McDonald's had not previously invested in any brand other than their own.

From very early on in the talks between our companies, McDonald's seemed to understand and appreciate that Chipotle was trying to do something quite unique. And what really made the partnership work was that McDonald's respected the differences between our two companies, and allowed us to build Chipotle in accordance with our own vision, to show that food served fast didn't have to be a traditional fast-food experience.

Throughout the course of our relationship, McDonald's made substantial investments in Chipotle, largely funding our growth from about 15 restaurants to more than 500. Along the way they invited us to learn from their history and they offered the help of some talented and experienced people. We are very thankful for this. We learned a lot during the course of our relationship with McDonald's, both from them as a partner, as well as from ourselves as we pursued a path of constant improvement.

Today, we have reason to be more confident than ever that we have the ability, the focus and the discipline to continue to grow Chipotle according to our vision. At the center of that vision is an intense focus, a focus on doing just a few things but doing them better than anybody else and then working tirelessly to constantly improve. By doing this, we remain relevant to our core customers.

So far, this focus has led us to find the best raw ingredients available, but we have also developed ways of cooking, which are more efficient, which make our food taste better and which increase food safety. And we continue to do this in an open kitchen, in front of our customers, in a way that allows our customers to customize their meals to perfectly fit with their tastes and dietary requirements.

So while things at Chipotle appear quite consistent on the surface, we are actually an incredibly dynamic concept and company. Our food is always improving. We are improving our people practices by creating a culture that appeals to the highest performers. We are learning much about how to design and build our restaurants in order to increase their durability, their functionality and aesthetic relevance.

We have improved our internal processes and financial controls so as to maximize our efficiency in every aspect of our business. And finally, with these improvements and others, we continue to further enhance our already solid unit economic model. But we know we have a long way to go and that we can improve in each of these areas and more.

Many people ask me what keeps me excited about my involvement in Chipotle. It is really the challenge of making every aspect of what we do better. And with the exciting opportunities which I see ahead of us, I plan on being involved for a long time. I'd also like to welcome all of our new shareholders. As you may know, the exchange conducted by McDonald's for Chipotle Class B common stock was significantly over-subscribed, showing that there was a great interest in and support for Chipotle among McDonald's shareholders.

Perhaps the most important thing for you to understand about Chipotle is the strength of our commitment to the vision of changing the way Americans think about and eat fast food. It's something that we believe throughout the company and a vision that we think holds great promise for Chipotle and for our shareholders.

Turning now to the quarter, we once again have achieved very strong results, which are really just a manifestation of our continued drive and discipline. Specifically, this disciplined approach has helped us produce an 11.6% increase in same store sales for the quarter and an increase in net income of 132% in the third quarter of 2006 compared with the same period in 2005. We also posted a 330 basis point improvement to our restaurant level operating margins, now at 21.5%.

Finally, we opened 30 new restaurants during the quarter. All of these measures continue to validate our focused and disciplined approach to running Chipotle, showing that by doing things better, you can grow the business efficiently and effectively without the need for new menu items or constant redevelopment of the concept.

I'll now turn the call over to Monty Moran, our president and chief operating officer.

Thank you, Steve. Steve has talked for many years about our focus on food with integrity and our commitment to the continued improvement of our raw ingredients. And clearly our focus on food will remain central to our vision and our strategy for the future. But during the last year we've worked to ensure that our corporate culture and our people practices are as exceptional as our food.

You've likely heard about many aspects of our renewed focus on people already. We've acknowledged that the restaurant manager is the most important position in the company. We created the restaurateur program to make a career out of this manager position so that we can retain our best managers in the stores where they can continue to positively impact the food and the customer experience.

We've prioritized developing managers from within because managers who are promoted from within our restaurants, from our crew, run better restaurants and are less likely to turn over than those who come from outside Chipotle. We created a new staffing structure within our restaurants to facilitate this development of our crew people to management positions. And while we just began these efforts recently, just this year really, we're already seeing very encouraging early dividends.

During the last weeks we've spent time meeting with each of our regional directors and their teams to discuss their accomplishments for 2006 and their goals for 2007. In each of our three regions we're seeing an increase in the number of our hourly crewmembers that are being promoted to management roles in our restaurants and we expect that this trend will continue. In fact, our internal promotions to restaurant management have increased from about a third earlier this year to nearly 50% today. Also, our turnover among store managers has decreased from over 40% this time last year to just over 30% today.

Finally, because these internally developed managers are typically higher performers, we're confident that we're going to begin to see the positive influences to our food, customer service, restaurant sales and ultimately our profitability. We have said we will only open stores as fast as we can find great real estate and strong managers to run those stores and we believe that this continued focus on people and their development is going to help us ensure that we can continue a pattern of strong unit growth, as Jack will further explain in just a moment.

Our recent planning sessions have given us the confidence that we have a strong pipeline of crew, kitchen managers and service managers so that we're going to be able to satisfy the majority of our new restaurant manager needs in 2007 solely from internal promotions. Recently we completed a comprehensive survey of all of our managers to learn from them what we can do to facilitate their development and success. The results of this will continue to help us build a culture that focuses on the managers' success and the resulting success of their restaurants.

But our discipline in building a strong culture is also showing great benefit to our corporate office and field staffing structure as well. It's enabled us to reduce our field ratios at the area manager, operations director and regional director levels while simultaneously making these positions more impactful and effective. We've also continued to resist adding to our corporate office by making sure that our very best people are in roles which allow them to be the most effective. These changes allow us to remain nimble and decisive while reducing G&A as a percentage of revenue.

Through elevating and empowering our best people, we will continue to improve our customer service and overall restaurant operations. We believe these efforts will eventually lead Chipotle to be as well known for its people and for its service as it is today for its food.

2006 is going to be our ninth year of double digit comp restaurant sales. The fact that we're able -- that we were able to accomplish this with almost no change to our menu over the last 13 years has made this incremental revenue very profitable, as we've been able to gain a significant amount of leverage in our margins.

I'll now turn the call over to Jack Hartung, our chief financial and development officer.

Okay, thanks, Monty.

Before we jump into the financial highlights for the quarter, I wanted to quickly review the recent exchange offer, which is finalized on October 12th. We were quite pleased to see that the McDonald's offering of our Class B common stock was vastly over-subscribed, which we believe is a huge vote of confidence in our brand and in the strategies we have laid out this year.

About 262 million shares of McDonald's common stock were tendered for the exchange and, as anticipated, about 18.6 million shares of McDonald's common stock, or about 7%, were accepted by McDonald's in exchange for the 16.5 million shares of Chipotle Class B common stock they held.

As you can imagine, we spent a great deal of time during the year and especially during the third quarter working through the separation from McDonald's and we're proud of the fact that we're still able to post terrific results for our shareholders. With the separation behind us we can now devote even greater attention to operating and opening great restaurants.

For the third quarter of '06, revenues were 211.3 million, a 28.3% increase from the comp quarter in 2005. Of the 46.6 million increase, 19 million was driven by the 11.6% increase in comp restaurant sales, while 27.6 million came from sales from new restaurants not yet in the comp base. For the nine months ended in September, revenues increased 32.8%. The 11.6% comp on top of the 11.5% comp from last year, was driven primarily by transaction growth.

But we also benefited from the 2.4% price increase we took in certain markets in the second half of '05 when we rolled out naturally raised chicken or beef. Through the third quarter on a trailing 12 month basis, our average annual restaurant sales have risen to 1,584,000, which is up dramatically from just over 1.4 million just one year ago. [inaudible] economics for both our existing and new restaurants have never been stronger.

We opened 30 new restaurants during that third quarter, bringing our year-to-date openings to 59 through the end of September. As expected, the pace of our openings picked up in the third quarter and we remain confident that we'll hit our opening guidance of 80 to 90 new restaurants in 2006. And in fact, if the fourth quarter continues as expected, we should end up toward the high end of that range.

Overall, the higher average restaurant sales, combined with the menu price increase, as well as lower avocado and other operating costs, helped to increase our restaurant level operating margins to 21.5% in the quarter, a 330 basis point improvement from the 18.2% we saw in the third quarter of last year.

Food, beverage and packaging fell to 31% of total revenue, down from 32.4 last year, which is a 140 basis point improvement. This improvement was driven by lower commodity costs, as well as the menu price increase from last year. Packaging costs, however, did rise in the third quarter, which is a trend that we have seen throughout the year.

As Monty stated, our people are of primary importance to us, both in terms of improving our day-to-day operations as well as customer service. The enhanced restaurant management structure, implemented earlier this year, should lead to improved training, increased internal promotions, better operations and better customer service. In the near term we increased our staffing as we transitioned to this new structure, yet we have held labor costs as a percent of sales steady compared to last year.

Occupancy costs were 7.1% of total revenue, a 30 basis point improvement from the third quarter of '05, driven largely by fixed costs spread over higher average restaurant sales. Other operating expenses fell 150 basis points to 12.2% of total revenue with improvements in bank and credit card fees, lower MIT costs, these are the training costs we incur when we hire managers from outside Chipotle, and lower marketing compared to last year. Our marketing spend to date this year is about 1.7% for the full year so far, about the same as last year.

G&A as a percent of total revenue fell 10 basis points to 7.4% for the quarter, which includes about 600,000 of legal, audit and other fees related to the McDonald's divestiture of our stock. And as we've guided all year, with [the added] public company costs, the stock-based compensation expense and the cost of separating from McDonald's, G&A has been and will continue to be flat or perhaps only slightly down as a percent of revenue versus last year. But beginning in '07 we expect to see G&A leverage again as we leverage our corporate and field infrastructure, which will play an important role in helping us achieve our 25%-plus earnings growth.

Pre-opening expenses were 2.1 million in the quarter compared to 381,000 in the same period of '05. We added 30 new restaurants during the third quarter of '06 compared to just 17 last year and, as you know, this year we began expensing rent during construction, including the straight-line rent. Prior to this change these costs were capitalized.

Net interest income was 1.9 million for the quarter compared to net interest expense of 248,000 last year and this was primarily due to the very high cash balance we carried during the quarter, which was 157.6 million at September 30. Income before taxes, income taxes increased 114% to 19.8 million compared to 9.3 million in the third quarter of '05, a 380 basis point improvement as a percent of revenue. Our effective tax rate was 40.4% for the quarter and we expect our annual tax rate will be about 40% for the full year. Net income was 11.8 for the third quarter, or $0.36 per diluted share, compared to net income of 5.1 million last year, or $0.19 per share.

Turning to operating cash flows, net cash provided by operating activities for the first nine months increased to about 73.5 million this year, up from approximately 52.6 million last year. This very strong cash flow, along with the 19.5 million we received from McDonald's related to our [inaudible] agreement, has allowed us to fund our capital expenditures so far this year and grow our cash balance from 121 million just after the IPO to this 157.6 million balance at the end of the quarter.

Most of our CapEx is invested in new restaurants, which continued to average right around 900,000 per restaurant, which excludes leasing expenses. And we've been able to maintain our new store investment right around this $900,000 figure for the past three years despite significant construction inflation. And we've done this by focusing on adding smaller restaurants to our mix and by building fewer free-standers. In the first year after opening, our new stores have consistently averaged about 85% of our existing store sales, even while our existing store sales have risen dramatically over the past three years.

As to the rest of the year, as we've guided previously, we expect to end the year with full year comps in the low double digits with the fourth quarter being the toughest quarterly comp for the year, as comparisons to last year's 14.3% comp is the most difficult. So the fourth quarter will be the lowest comp we'll see this year. Note that last year's 14.3% comp did include a 1.6% from -- benefit from menu pricing, which is when we rolled out the natural beef and natural chicken to several markets in the fourth quarter.

We remain confident we'll open near the high end of our guidance of 80 to 90 new restaurants for the year. We also expect non-cash stock compensation expense of about 5 million for the year and effective tax rate of 40%. We expect diluted common shares outstanding of about 32.5 to 33 million.

Longer term we believe we'll be able to grow diluted earnings per common share at an annual rate of at least 25% and while the comps and margin expansion were the significant drivers of growth in 2006, we expect that new restaurants and G&A leverage will play an increasingly important role going forward. Specifically in '07 we expect our growth to be supported by 95 to 105 new restaurants, along with comps in the low to mid single digit range.

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

Thank you.

[OPERATOR INSTRUCTIONS]

And we'll take our first question from Larry Miller from RBC Capital Markets. Please go ahead.

Hi, guys.

Hey, Larry.

Wondering if you could just help me understand your same store sales guidance for 2006 and maybe even '07. But specifically on 2006, you're talking about low double digits for the year. That was something -- that would imply something like flat to a low single digit comp in the fourth quarter and I'm curious, is there something you're seeing that's causing you to guide to that leverage -- to that level? And then looking out into '07 with the low single digit to mid single digit comps, can you give us an idea of what level comp you would need based on the cost environment today to see flat margins in '07? Thank you.

Thanks, Larry. In terms of '06, no, we're not expecting flat or very low margins in the fourth quarter. What we're really saying is we expect fourth quarter to be the lowest comp of the year and its' a function of two things. One, we're going up against the toughest quarter, so we're going up against 14.3. And you'll notice if you followed our comps throughout the year for the first, second, third quarters, they've gone down gradually each quarter as we've gone up against tougher and tougher comps, so we expect a similar trend.

The only additional thing that I would add to that is we are going up against, for the first time, the price increase we took last year. And so as an example, in the third quarter, as well as the first and second quarter, we benefited from the full 2.4 to 2.7% menu price increase that we took at the last half of last year. Now we're going up against 1.6 of that, and so we expect to have a lesser benefit on that menu price increase in the fourth quarter. So we still expect to see our sales trends to be very strong, [inaudible] percentage comp increase in the fourth quarter we expect to see -- to be down a little bit.

In terms of your '07 comment, I think it was really around margins. '06 was a great year for us from a margin standpoint. Not only did we have very, very high comps and so we were able to drive very strong economies of scale and that's why you've seen a very strong margin expansion this year, but also commodities were the best we've ever seen. Our avocado, our chicken prices, our beef prices, everything not only remained steady, most of them went down, avocados in particular. So we do see margin pressure.

If there's pressure on margins, either up or down, we would say it's more up next year than down. We do think that the comp guidance that we've given, if things hold pretty well, if we don't have any surprises in terms of inflation or in terms of, you name it in terms of increasing costs, we think we'll be able to probably eek out about the same margin.

If we feel significant margin pressure, though, we will go to the menu [board]. We think we've got menu pricing ability. We'd rather, as you now, hold onto that menu pricing ability when we have food and [inaudible] rollout, but if the margin pressure is significant and we don't have an imminent significant food [inaudible] rollout, we'll go to the menu board.

Thanks, Jack. That was a great answer. Can I ask one more question, if I may?

Sure.

Okay. Can you just [dimensionalize] a little bit for us the operating expense savings there? It looked like -- you didn't mention the sales leverage, so you did mention a few other things. And I was curious, contribution-wise, what those might have been?

Yes, they're definitely sales leverage. It kind of depends, Larry, on where you put inflation, but I think the best way to think about it is there were three big things that drive our margin expansion. One was the menu price increase, two was the commodities and three was sales leverage. And I would say that all of them were pretty close in terms of contribution.

I was just talking about the other occupancy costs specifically, I'm sorry.

Oh, okay. We got about -- of that I'd say about two-thirds of that was driven by cost savings, okay? And then the rest was driven by fixed costs and higher sales.

Is that something we should expect to continue?

I think the cost savings, yes. But the credit card thing is -- we have a new contract and we'll dramatically save on our credit card fees. Marketing is a temporary thing. Our marketing spend will go up and down during the quarters, but overall for the year, this year, last year, next year we expect to spend about 1.75%, so that will not be a consistent savings. And then the third piece was on MIT. We're spending a lot less money on these training costs because we're training more of our people internally and so that's in the labor line so that we should see some savings going forward.

Thank you, very much.

Sure. Thanks, Larry.

We'll take our next question from Nicole Miller from Piper Jaffray. Please go ahead.

Hi. Could you help me quantify, Jack, the stock option expense? Was that about $1 million in G&A in the quarter?

For the quarter it was about a million, yes. We still expect it to be 5 million for the full year.

And that's pretax, correct?

And that's pretax, exactly.

Okay. And looking at the pricing in the quarter, so it was 2.4 to 2.7, is that right?

It was 2.4 in the quarter. It's ranged from 2.6 -- we had one quarter with 2.7 and then 2.4 and really, Nicole, that's just a function of what the product mix is during the quarter and so if the product mix shifts, either away or towards items that we increase menu pricing on that will shift. By the way, the specific number on the stock option expense is 800,000, Nicole.

Pretax?

Pretax, yes.

Okay, thank you.

Sure.

Okay, to go back to the comps, it was 2.4% but you're saying that price was basically a function of primarily mix? So is there a certain percentage of price that you are rolling on right now?

No, I'm sorry. Let me clarify that. We got a full 2.4% due to menu price increases...

Okay.

...quarter to quarter you've heard us say that we've gotten a benefit of anywhere from 2.4 to 2.7. That 30 basis point difference between the 2.4 and the 2.7 was just difference in mix form quarter to quarter, but we got a full 2.4% benefit from pricing in the third quarter.

And do you know what you benefited from mix shift in the third quarter?

No, it's not -- no. It's not significant, though.

Okay.

It's mostly -- the rest of it is mostly transactions.

Okay, great. And then the fourth quarter prior price falls off, so just to confirm, [we're rolling on] 1.6 or that's what falls off?

I think the comparison, Nicole, is we get another 2.4% in the fourth quarter, we're going up against 1.6 and so the pricing benefit we get will only be 80 basis points, not 240 basis points on the comp.

Right. Okay, so it --

[inaudible]

...falls 1.6 to 0.8% price.

Yes.

And what is the pricing power ultimately in your mind? Like, what average check experience should Chipotle be over time? Or to --

[technical difficulty] never seen resistance. We've always raised prices when we have to with integrity and in some cases when we haven't had to, we do it with integrity and we've seen zero resistance. So we know we've not even touched the point of resistance yet.

And --

[We think it's] significant, but we could not quantify it.

And at this point in the fourth quarter you have not increased the menu price? You have not replaced the 1.6 that rolls off?

We have not.

So obviously you're not seeing the comp pressure that you would be speaking to that could potentially happen in '07 where you're saying -- you suggested you would take price. So we could then assume comps are fairly strong quarter to date?

I'm not sure I understood that last thing. Can you -- can you say that again?

Okay, so you made the comment on the prior question you would take price if you saw pressure going into '07 either on comps, or I guess it was more specifically margin. And so --

Yes.

...you're not seeing that margin pressure because as of two months through -- or as of a month through this quarter, excuse me, you haven't needed to take that price.

No, that's right, Nicole. We have -- so far commodities have still -- they've crept up a little bit...

Okay.

...but not very much. My main point in answering that question is we feel there is pressure, more upward pressure on some of our cost items, like avocados, like chicken, like steak but we believe that if those pricing pressures become significant, our first choice would be to have food with integrity opportunity to roll out, we'd increase prices at that time. But if the pricing pressure is significant and we don't have food with integrity opportunities imminent, we would go to the menu board and make sure that we preserve those margins.

Okay, great. And then my final question is would you be willing to quantify quarter to date comps -- comp results?

No.

Okay. Thank you, so much.

We'll take our next question from [Paul Wester] from Cohen & Co. Please go ahead.

Great, thanks. Good evening, gentlemen.

Hey, Paul.

Hi, Paul.

How are you? Just a quick question on your -- what your sense is of seasonality of the brand. We've seen the shift a little bit in the fourth quarter in the last three years where fourth quarter was your comparably light quarter from a seasonality standpoint and strengthening to one of your stronger quarters. Can you give us an idea of what you think is going on with the seasonality?

Yes, Paul. We believe our seasonality has been and continues to look like this. Our second and third quarters are always strongest from a sales standpoint, so when we look at average daily sales, those are always our best quarters. And then the first quarter and the fourth quarter are always our weakest quarters from an average daily sales standpoint. As a result of that, the first and the fourth quarters are typically our weakest from a margin standpoint as well and the second and third are always our best quarters.

I think that this past year, with a very high comp in the first quarter of this year, the 19.7, and then last year, the highest comp of last year at 14.3, I think you might have seen what appeared to be a smoothing of the seasonality. We won't know for sure until we go fully up against the fourth quarter and fully up against the first quarter of next year, but we think that that was just -- those were spikes in the seasonality because we've already in September seen that our sales just in terms of natural seasonality have begun to level off as the weather has gotten a little cooler, as kids go back to school and things like that.

The other thing I would tell you from a seasonality standpoint, Paul, is just from the opening standpoint, when we back-load our openings, as we have done the last couple of years and we've especially done this year, that has an impact on our margins. And so typically our fourth quarter margins are a little bit lower. They're driven down a little bit by these -- by these very significant number of openings in the back half of the year.

Great. And then second question on your [25 in EPS] growth outlook with a mid or low single digit comp outlook and, as you already mentioned on the call, maybe a flattish margin scenario, it seems to bake in some pretty significant G&A leverage to get to that 25% growth rate with your unit [opening items]. Can you talk about your G&A? Are you looking pleasantly surprised about the ability to leverage, like you're already seeing?

We're very confident that we have significant G&A leverage. And first of all, let me look at the pieces. With the 95 to 105 openings, that would -- that results in a 17 to 18% or so sales increase from just the new store openings. We believe that we'll [be better level loaded] next year. Our inventory building has gone very well this year. That's why we've been able to give the higher guidance of the 95 to 105, but we think we might get a little bit more sales increases from level loading as well.

but let's say that number is in the 17 to 18% range. With the comp guidance we've given, that would put the total sales growth in the low 20s to mid 20 range. We're very confident that we've got G&A leverage that will take us at least to the 25% and then beyond that as well.

When we think about it longer term, Paul, we think that we have -- we'll finish this year in the low 8% G&A as a percent of revenue, so call it in that 8.2% range. We believe that we can get down into the low 7s within a couple of years, so we think we've got probably 100 basis points of G&A leverage at least within the next couple of years. So we're very confident about that.

Great. And then more of a strategic question. I know you mentioned about your buildout costs being firm at 900,000, but I sense your buildout per square footage on an apples-to-applies [whether its in line] and unit scenario has, in fact, risen. Are you happy with the strategy of going after maybe small units? I'm more curious about your dine-in and dinner business suffering with that type of strategy.

We're very happy, Paul. We've not seen any degradation of our new store openings. We've maintained this kind of 85% of our existing store average and that's even during a time when our existing store average moved from 1.4 million to [1.585] million. So we're very happy with the [inaudible] free-standers, very happy with the smaller restaurants, and we're not seeing any kind of pullback on sales --

Even --

...at all.

Even on the dine-in portion?

Well, we've seen a shift even before we started this. We've seen a shift where we have more takeout business. And so we continue to see a shift but I wouldn't say we're seeing a change in that trend line, Paul. So we're a little bit more than 50% takeout right now. But we're not seeing, like, a sudden shift in that.

But just to recap, I kind of recall that your [inaudible] takeout, at least in the late '90s, early 2000s, was high takeout, most of your growth in the early 2000s was for dine-in. If I'm mistaken, correct me, please.

I think, Paul, I think that's not really the case. I think what we've seen over the last many years is a shift from more dine-in to generally more takeout sort of gradually, but it's been very slow and very gradual so now it's just -- maybe just over 50%. But also on the dinner side, we've actually seen our dinner business grow compared to lunch, even a little bit more so that dinner is now slightly over 50% of our business as well. So we haven't seen any negative effect on that.

Maybe it was the dinner portion that has grown from the 30s or 40s to the 50% range, is that correct?

Oh, yes --

Yes, that is true.

Yes, that's right. Even then, Paul, it just happened kind of naturally. As you know, we've not added menu items to try and attract people at dinner. That just kind of happened naturally as people figured out that they wanted a burrito for dinner.

And I guess one more thing is on the smaller stores, we have built some smaller stores but that has not been the majority of what has affected development costs, just to clarify that, Paul. That's been a few stores mixed into a bunch of stores, a few of them that are smaller, and that's not really what affected the development costs.

Thank you.

Thanks, Paul.

Thanks. Bye.

And we'll take our next question from Jeff Omohundro from Wachovia. Please go ahead.

Wonder if you could talk a bit about some of the convenience initiatives in the Chipotle [DSL], how that is performing in terms of sales mix, and maybe an update on the drive-through test I think you've been exploring as well?

Well, we haven't tested a drive-through. I think maybe where you heard that was somebody had asked us about drive-through in our future and I think we said we're open to that. We don't have a particular drive-through test at this time. We are going to lease -- or we have leased and will surely open a store on Long Island which used to have a drive-through when it was a Krispy Kreme I think, but we're not going to open that with the drive-through open. But we are going to maintain the ability to perhaps do that at a later time.

So with regard to DSL performance, as we may have expressed in the past, we have not marketed our DSL much and frankly because it is a new system from a technological standpoint and we have a bunch of things that we're undertaking now to really sort of shore up the technology of the DSL system and to make sure that it works really, really, really well before we actually market it. Now, that being said, we have had a lot of transactions from DSL that's grown -- it's grown dramatically. We've had more than $1 million worth of sales from DSL and if you combine DSL and fax orders, it's between 3 and 3.5% of our business at this time.

Great. And then just a follow-up on the tax rate and the 40% guidance. I'm just wondering what initiatives around that you might have and if you can give us any color on '07 tax rates, that'd be helpful.

Yes, Jeff, the tax rate is going to be right around 40% and that's a function of the federal rate's going to be 35, there's nothing we can do with that. We don't have international business, we don't have any tipping so their casual dining restaurants can take a tax credit and move that down. So then what you've got left is state taxes and our state taxes we expect to be around 5%.

We are beginning to do some state tax planning now that we've got the separation behind us. We jut got to looking at state tax planning to see if we could try to notch that down -- knock that down a couple of notches. But we still will be in, if not the 40% range, in the high 30% range. I won't give you any specific guidance right now but I would -- in terms of thinking about our taxes for next year, I think a safe assumption is 40%. Hopefully we can knock that down a notch or two, though, as we -- as execute some state tax planning.

Very good. Thanks.

Thanks, Jeff.

And we'll take our next question from Laurie Hahn from Deutsche Bank. Please go ahead.

Hi, guys.

Hi, Laurie.

Hi, Laurie.

Hi, Laurie.

Wondering if you could touch on your labor cost line and how you see that playing out in 2007 as a percentage of sales, particularly in light of the new management program, and now that you're into it how much pressure you could see from that? And also, if you're worried at all about how any minimum wage increases might impact that line?

Okay, yes, thanks, Laurie. Generally speaking, sort of cut to the chase, on the labor side we have sort of flattened out any degradation in margins that came from labor and it's -- and we believe it'll start trending down and that we'll be able to find some leverage in labor in 2007.

In terms of the management programs you mentioned, one of the significant things that had an initial labor impact was our new staffing structure in the restaurants, which, as I described in my opening comments, has had really positive benefit on the amount of internal promotions, the decrease in turnover and the corresponding benefits from the savings on the MIT side -- excuse me, the training savings from our MIT program and also savings that happened as field ratios get better.

That being said, when we really studied how this is affecting us, what we found is that putting this new structure in place had sort of a one or two-month effect in our restaurants where it did have an upward pressure on labor, after which time it -- the labor tended to return to sort of a normalized level. So we're very confident that in 2007 we're going to be a steady state in that regard. Anything to add to that, Jeff?

No. Just, Laurie, one thing I want to add is the MT costs that I mentioned and the other operating costs are down about 30 basis points and that's down from last year 40 basis points. This is the time of the year where we're spending a lot of money bringing a lot of people from outside Chipotle and to train them. We're just not doing that much anymore and so it's costing us a lot less. So even though our labor line looks like it's flat, there's a 30 basis point improvement that we're getting in the MIT, which is kind of a benefit as a result of this new labor structure.

We also recently moved the whole company to one labor matrix. Previously we had a bunch of matrices out there. And so we think that while we'll continue to have some additional investment in labor going forward, we do think we'll start to see some leverage, if not in the fourth quarter, hopefully early next year.

And I guess, Laurie, you also asked about the effective minimum wage. At this point, basically we have not seen any negative effect from any pressure on minimum wages. As you know, we don't have anyone paid really that close to the minimum wage and so it doesn't tend to affect us. But even as there's -- even though we've heard there's some upward pressure in wages, we have not yet seen that. Should we see it, again, we feel like we do have some protection from the fact that we can go to the menu board if need be, if there is a significant upward pressure in '07.

That's helpful, thanks.

Thanks, Laurie.

We'll take our next question from Steven Rees from JP Morgan. Please go ahead.

Good afternoon. Thanks. With the focus mostly on existing markets next year, I was wondering if you could talk a little bit about some of your more penetrated markets, how the new unit volumes and margins trend over time and how much cannibalization, if any, you see as you build out a market?

Yes. Steve, first of all on the cannibalization, we track every single site and we estimate -- we estimate impact in every single site and this is one area we're able to benefit from some of the thinking that McDonald's had. They've had years and years and years of dealing with impact and so we were able to take those models, adapt them to what we do, and so we'll estimate impact in every single site and we'll make sure that before we invest in a site that the after-impact return meets our expectations.

Having said that, across the board we have -- most of our openings don't have any impact at all, but when you take into account the impact that we do have, it ends up being about 1% of the comp, so a relatively small amount kind of comp. In terms of our penetration of existing markets, our new stores across the board are opening up very well. That's in existing markets as well as in new markets.

And so we continue to be happy with the new openings and existing restaurants, our existing markets, those restaurants are cash flow positive virtually right away, in month one, and they're hitting kind of a high teens type of cash margin within the first 12 months.

And so those are pretty quick return stores from that standpoint. The new markets take a little bit longer. The P&L takes a little bit longer to come onboard. We have higher distribution costs, we have higher -- takes a little bit longer for us to get our labor where we want it to be and, in fact, we don't push that labor down too hard because we want to make the right impression with the customers. So but we're very pleased with the openings at both existing and new markets.

Okay, great. And then 2006 you focused a lot on speed of service initiatives and I just wanted to know what the next wave in 2007 will bring in terms of opportunities to increase throughput at the restaurants.

Okay, well, we just had a meeting, the meeting I mentioned during my opening comments, with our three regional directors and we talked about throughput and what opportunity we believe continue to exist on throughput. And all three of the regional directors were extremely bullish that there was a lot of room yet to go on throughout.

One example of where they thought there was a lot of room for improvement is dinner. Our initial focus and sort of the most obvious bridge to cross with our throughput was our lunch because our lines are sort of famously long. And but the truth is our dinner lines are also very long and yet we hadn't put as much of our focus on reducing the wait times at dinner.

That being said, the really good news is we just recently met with and had a study done by a third party who had done a study for us a year ago on throughput and they studied a number of our stores over a period of time and found that our customer waiting times have decreased pretty dramatically. In fact, to quantify it, on average our customers are spending less -- over a minute less time waiting in line and that improvement had been both at lunch and at dinner.

84% of our customers now spend less than five minutes in line whereas only 70% got through that fast a year ago. And they also found that we're faster at every single part of our service along the line from the tortilla station all the way through checkout. So what all this adds up to is our crew labor is spending a higher percentage of their time engaged in customer service, which means we're using our crews better, but also that our customers are waiting for -- spending less time in line so it's increasing the quality of their experience. So we think there is substantial room for gains there.

Another thing that we're doing very specifically for 2007, in fact this will go into play late this year, is we're going to be putting change machines in all of our restaurants that don't currently have them. Right now we only have them in about 50 of our 540 restaurants.

So they're going to be going into almost all of our restaurants and these change machines save about four seconds per transaction, per cash transaction that comes through the line and that adds up very, very quickly since our -- we're able to conduct transactions in somewhere between ten and 12 seconds at our faster restaurants.

So each -- basically for each three cash transactions that will take place after we get a coin machine, we'll be able to get an entire additional transaction just during our peak hours per hour. So that's just one example of a number of things we're doing to continue to increase the ability to deliver that speed during our peak hours.

And the coin system -- the coin machines will be in place in 2007?

They'll be in pace actually by late 2006. So yes, by '07 you should see change machines just about all the Chipotle's of any volume whatsoever.

Okay, great. And then just forgive me if I missed it, but on the all-natural initiatives, can you just update us where you stand in terms of the system, who's got it, who doesn't?

Yes. I would call it the food with integrity initiative. Natural meats, meats that are naturally raised, and we define that as chicken without antibiotics, an all-vegetarian feed, beef without antibiotics or added growth hormones and an all-natural -- or all vegetarian feed. And pork, the same, no antibiotics or hormones and an all-vegetarian feed. Additionally, they're raised either outdoors or in deeply bedded farms.

We are right now getting ready to roll out in two to three markets naturally raised chicken. We're not allowed -- or we're not prepared to say which markets. That'll happen before the end of the year. We are ahead, really, of schedule in terms of our desire to have naturally raised meats in all of our markets. Again, we said it was a two-year project about -- almost a year ago or so and we are making a lot of progress on that.

But it goes beyond the meats. We certainly thought meats were the priority. It goes beyond the meats. We started looking at opportunities where we won't necessarily have to increase the price for better quality food and one thing that we did with our sour cream supplier earlier this year was ask that we have the sour cream made from milk that is from cattle that is not treated with recombinant bovine growth hormone, or RBGH.

And we are proud to say that as of -- or upcoming this October 11th, all of our supply of sour cream will be produced using milk from dairies that do not treat their cattle with RBGH. And there's no additional cost that we'll be passing on to the consumer for this and there's no additional cost to us either. And we think this is a very responsible thing to do and, again, really just one other food with integrity piece of the puzzle.

But again, remember, food with integrity is looking at every single one of our individual raw ingredients and making them better not only for taste, but also in terms of sustainability.

Great. Thank you, very much.

We'll take our next question from Bryan Elliott from Raymond James. Please go ahead.

Good afternoon. Just a couple that haven't been asked. Actually, that was the big one, was that one. Actually, on the food with integrity, can you update us on sort of the -- coming back to the meat side of it, you say chicken you're going to get [inaudible] supply for three more markets and you're ahead of plan. So clearly you're seeing increases in supply out there.

That's correct and we have been working very closely with suppliers over the years and we've brought on a lot of new suppliers, smaller suppliers, which has helped. But additionally, we're working with some of the larger traditional commodity suppliers who are willing to look at their protocols and adapt our protocols especially for us. So we've been making progress on really both fronts of this -- of the meat initiative, coming from not only traditional supplier but also finding a lot of new smaller suppliers to meet the increasing demand.

Great, thank you. Also a couple of follow-ups. The MIT costs, are those -- Jack, are those in other operating or labor?

No, they're in other operating.

Okay, and those are coming down a lot because of the changes you've made. The internal promotions, those training costs are in labor costs, correct?

Yes, exactly. So that's why, Bryan, we've added labor and we've got training costs, if you will, in the labor line now and that's why you're seeing no leverage. But we know there's 30 basis points of leverage that we're seeing in the other operating.

Right. Now, you also mentioned, if I heard correctly, I just want to clarify that after -- when you put in the line manager and the kitchen manager personnel that you see the impact of that in your labor line for a couple of months, but then you are able to offset that. That sounds relatively quick for sort of a permanent increase in what I would characterize as sort of a permanent increase in the cost structure. Can you help take that out a bit?

Yes. And, Bryan, the way I would say that is we had a handful of stores that were able to do that so that these guys were ahead of the game already. They had had a jump on implementing the new structure, and so they jumped into it and they were already fully staffed. They already were running great restaurants and so when they implemented this new restaurant structure, it was relatively quick for them and so they had the ability to relatively quickly get their labor right back in line.

We didn't have that luxury when we rolled this out to all 500 or so restaurants and so that's why you see it's taking a little bit longer. We don't want to push this. We're delighted with the pipeline that we're getting, we're delighted with how many of our crew are stepping up and saying I want to be a kitchen manager, I want to be a line manager, and we know that's where our -- that's where tomorrow's talent is going to come from.

And so we've been patient behind the scenes. We're pushing hard but we've been patient to make sure that we're doing the right things for the right reason. We feel good about the fact that our labor has held steady, has not increased, and we do expect that our labor costs will be able to drift downward as all of our stores have fully implemented, feel like they're fully staffed, and really gain some momentum with this training that is underway.

Moving on to the throughput, last quarter I think you mentioned, if memory serves, you saw a sequential increase in transactions per hour at peak lunch hour of, I believe it was 8 from second -- to second quarter from first quarter. Can you update on that what you -- us on what you saw Q3 versus Q2? Is there an incremental improvement also sequentially?

Yes, sure. Jack earlier answered the question with regard to seasonality and pointed out how the third quarter -- late in the third quarter and going into fourth quarter things -- our sales slowed a little bit due to the cold and whatnot. And because of that we have seen a sort of a leveling off of our average throughput in our average restaurants.

What gives us a lot of confidence, though, is that in a lot of our higher volume restaurants that have sort of a huge supply of customers at lunch, we're still able to see a lot of throughput gains at those stores, even -- or at least holding the throughput they already had, even as that seasonality affects our average daily sales downward by 100 or $200.

All right. Last question to Jack I guess, the credit card renegotiation, just a broad question, do you get the sense that there's more competition maybe? And there's been a lot of fee pressure for a couple of years in that line item across the restaurant industry, are people getting more competitive out there? Is there a chance that from a global industry standpoint that might cease being a pressure point and maybe even back off a bit?

Bryan, you hit the nail on the head. It is absolutely driven by competitive price here. It's in the processing part of it, by the way, not the fees. The credit card companies are not charging lower fees. What has happened, though, is with technology companies have gotten more efficient. And so we did have a competitor come in, offered to do the processing, and we had engaged with that very significantly and we were going to save a whole lot of money, we were ready to make that change.

As it turns out, our existing vendor came to us and matched their offer, in essence. And so we saved a lot of money because of the competitive pressure. But it's all in the processing costs. We are not seeing any savings whatsoever in the fees that the credit card companies themselves charge for their -- for using their brand, if you will.

So obviously a subjective question, but just to finish that thought, given your substantial size increase you obviously have a lot more scale and buying power, but it sounds like, if I'm interpreting you right, that there was more than just that that accomplished the decline. There's a competitive change out there among the suppliers.

It is more driven by the competitive change than anything. I will tell you we did benefit, because we started these negotiations when we were part of McDonald's and McDonald's was moving forward with their credit card program as well, and so we benefited from being part of them. We were able to retain basically that benefit. But it really is the competition out there is good, is getting good.

Very good. Thank you, very much.

Thanks, Bryan.

And we'll take our next question from Mark Wiltamuth from Morgan Stanley. Please go ahead.

Good afternoon. Jack, a question on the eight franchisees that you had from McDonald's. Have they made any decision on what they're going to do with their stores and could that be used as some of the cash you've got on your books there?

Mark, they have not communicated that to us. We've said we are fine with them continuing to run the restaurants. And if they'd like to sell, we'd be happy to talk with them as well. But they have not come to us and said either way.

Is there a timeline on when they need to decide?

Not as far as we're concerned. McDonald's has a contract where they contractually have the ability to force them to make a decision within two years. But from our standpoint, no, we're happy with them if they want to run the restaurant until the end of their franchise term, which was an initial 10-year term from when the store opened.

Okay. And you mentioned about a leveling of your store growth. So you're feeling like per quarter you're going to be more level this year instead of back half loaded?

Yes. The way I would say it, Mark, is we were -- we open about a third, depending on where we finish this year, around a third of our openings in the first half of the year. I wouldn't expect us to be perfectly level loaded next year, but in the first half of this year I think we'd be somewhere between a third and half.

Okay. And do you feel like there's a sustainability of your restaurant level margin up in around that 20 to 21% range if you do those comps as advertised?

Well, I'm hesitant on that because I am concerned that this was such a good year that next year there could be some unusual things going the other way. And so it is possible that if we did nothing and just had these comps, it's possible that our margins would be under pressure. That's why I wanted to make the comment about our pricing power. If we have to, if we see a structural change in our commodities such that we are seeing pressure on our margins, at some point we may go to the menu board even to preempt waiting for food with integrity.

Okay. And in this fourth quarter you got coming up with the heavier restaurant openings you'll have here, the pressure and the drag from more openings is going to come more on the SG&A side or a little bit on that restaurant level margin also?

SG&A, I would assume about flat G&A leverage in the fourth quarter compared to last year. But I would expect to see some pressure on the margins because remember, what we've got is we hit near the high end of that range, we'll be opening somewhere around 30 restaurants in the fourth quarter.

We also have the 30 that just opened up in the third quarter. So you've got inventory P&Ls for the 30 we just opened plus inventory P&Ls for the 30 we're about to open. So you have 60 P&Ls that are going to be a drag. But it's on the P&L, not on the G&A. The G&A assumes virtually zero leverage from the fourth quarter of last year.

Okay. Well, that's good perspective. Thank you for your comments. Thank you.

Thanks, Mark.

Well take our next question from [Andy Parish] from Bank of America. Please go ahead.

Hey, guys. Just a quick [up-tell] on that last question on the new unit inefficiencies. You didn't really see anything here in the third quarter, so is that kind of opening later in the quarter or are you doing anything different just procedurally when you get those units open?

No, we did see some, Andy, in the third quarter. So our margins would have been better if we had opened, for example, fewer restaurants. The fact that we opened 30 this year versus 17 last year, we did see a hit on our margins. It wasn't a big hit, though, so I -- and I want to emphasize it was an incremental 13 restaurants over last year and so it's going to be -- going to be a bit bigger. I guess last year we opened 28 in the fourth quarter, so it won't be dramatic degradation, but there is going to be some pull.

Okay. And then on a follow-up on kind of the area manager and supervisor sort of field positions where it sounds like the span of control can -- these guys are probably managing fewer number of units than they're capable of doing. Can you give us a sense on number of units per area manager or targets that you're heading towards with those folks?

Well, I can tell you right now we are at seven and at the time of the road show back in January it was 6.11. If you looked at it a couple of years ago it was down sort of in the low five range throughout 2002, 2003, I should say high fives in '03. So we've been making steady progress over the last couple of years.

In terms off where they can be, it really -- it's a function on how quickly our restaurateur program and our program of internal promotions raises the average quality of our manager. We're seeing that that is working. We're seeing that the turnover of our managers is going down and therefore we have more experienced managers in the restaurants. We expect that trend to continue and, as it does, that is the single biggest gating factor that would allow our area managers to handle more restaurants is when their managers are mature, good, solid managers.

So we don't have a particular sort of number in mind where it can get, where it will be in a year or two, but we think that the certainly sort of eight, nine, 10 restaurants per area manager instead of the seven where it is now would be a very achievable goal over the next few years.

Thank you.

You bet. Thank you.

Thanks, Andy.

At this time we have time for one more question. We'll go to Rachel Rothman with Merrill Lynch. Please go ahead.

Hi. Good evening, guys. Could you just remind me when your stores open at what volume they're opening versus your average? And then what the ramp-up is each year in the three years following that, so is it --

Yes.

...that they open [at high] then they comp up ten or 15? Can you just remind me on what the trajectory is?

Yes, Rachel. They open up at about 85% of what our stores open 12 months or more are, and so a year ago they were opening up at about 85% of 1.4 million. Now they're opening up at about 85% of 1.585. So that numbers' going up nicely and really proportional as our existing stores have grown.

And so what that does is that puts you within a couple of years of very reasonable comps to get up to what the current average is. There's not any specific pattern in terms of they open up and do a 10% comp or 15 or 20. It varies by market; it varies by how much they open at. But we're very comfortable that on average, within a couple of years worth of comps, opening up at 85% they can get up to the -- what our current average is.

Is there a generalization? Is it on average of they open at 85% of volume, is there some average that in the first year they do 10 to 15?

By year three we're very comfortable. By starting at that level, by year three they are at or above our current average.

Okay.

The average when they open.

Okay, thank you.

Thank you, Rachel.

And at this --

Thank you all for joining us today and we'll; look forward to talking to you again in the near future.

Once again, ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may now disconnect.