奇波雷墨西哥燒烤 (CMG) 2007 Q2 法說會逐字稿

Good day and welcome to the Chipotle Mexican Grill Second Quarter 2007 Earnings conference call.

At this time, all participants are in a listen-only mode and the floor will be open for your questions following the presentation.

Also, today's call is being recorded.

It is now my pleasure to turn the floor over to your host, Ms.

Sandra Curlander, Investor Relations for Chipotle Mexican Grill.

Please go ahead ma'am.

Thank you.

Hello everyone and welcome to our call today.

By now, you should have access to our earnings announcement released this afternoon for the second quarter ended June 30th, 2007.

It may also be found on our Web site at chipotle.com in the Investor Relations section.

Before we begin our presentation, I will remind everyone that parts of our discussion today will include forward-looking statements within the meaning of the securities laws.

These forward-looking statements will include projections of restaurant comp sales trends, the number of restaurants we intend to open, earnings per share, certain expense items and other statements of our expectations and plans.

These forward-looking statements are based on information available to us today and we are not assuming any obligation to update them.

Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements.

We refer you to the risk factors in our annual report on Form 10-K for 2006 as updated by the 10-Q, which we expect to file this week for a discussion of the risks that could impact our future operating results and financial condition.

I want to remind everyone that we have adopted a self-imposed quiet period restricting communications with investors during sensitive periods.

This quiet period begins on the first day of the last month of each fiscal quarter and continues until the next earnings conference call.

For the third quarter, it will begin September 1st and continue until our third quarter release in late October.

On the call with us today are Steve Ells, our Founder, Chairman and Chief Executive Officer, Monty Moran, our President and Chief Operating Officer, and Jack Hartung, our Chief Finance and Development Officer.

After their comments, we will open the call for questions.

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

Thanks, Sandra.

We are very pleased that we are sharing more great news with you this afternoon.

Our 11.6% comp for the quarter and 10% comp for the first half of the year are obviously really exciting and our margin expansion is quite an accomplishment during a time when the marketplace has been concerned with pressure on major items such as labor costs and food costs.

So, obviously, we are very pleased.

But, what gives us the most comfort is that these results were gained through applying the same discipline and strategy that I talked about in previous calls, the discipline to focus on just a few things and just try to do them better than anybody else.

For Chipotle, that means cooking great quality raw ingredients according to classical cooking techniques in an open kitchen in front of our customers and in an atmosphere that's relevant to the dining experience.

And it means providing a level of conscientious service that is usually unknown in a fast food or quick service environment, and we are proud because we think we do these things better than anybody else.

We believe our continued focus is central to maintaining our strong unit economic model.

But, conversely, it's this unit economic model that allows us to focus on these things in a way that would be very difficult to replicate, which gives Chipotle a rather unique advantage.

For instance, because of efficiencies elsewhere on our P&L, we are able to invest more in our food, buying increasingly high quality ingredients.

We are also improving how we prepare our food, designing more efficient equipment and optimizing elements of our restaurant design that help our managers and crews deliver a better food and better customer experience.

As a result of this focus, restaurant level margins increased to 23.2% for the quarter, and increased EPS growth by more than 81%.

In addition, we continued to deliver this performance, while opening 32 new restaurants in a quarter, bringing our total openings to 60 year-to-date, maintaining our sharp focus on few things, takes a great deal of discipline.

There are many new ideas and innovations that we come up with, which could alter how our Company functions and managing the business.

It's our job to decide which of these ideas will help us to be better at what we do and which will end up being a distraction to the continued focus and success.

And we have passed on some of these ideas, such as offering breakfast, desserts, or other new menu items based on our conclusion that we would be better served improving our present format.

But, we have embraced others including new building designs, new equipment and new people development practices, which we believe will help to create a better environment for our employees and our customers.

I will share a couple of examples of some of these recent innovations.

We have developed and are in the process of implementing a much improved tortilla press, which will allow our crews to not only serve hot or more evenly heated tortillas, but to do so more quickly and with less effort.

We are also completing designs for a new grill, which will allow our crews to grill our meats in a way that tastes much better, is more consistent and which is also easier for our crews to clean at the end of the day.

We are redesigning our second make line to function better and more efficiently so that we can fill our orders more quickly and with the best tasting food possible.

Finally, we are continuing to improve the design and the functionality of our restaurant buildings so that they are more cost effective and at the same time improving their appearance, the durability, comfort, functionality and of course, aesthetic.

These and other innovations help us to take what we do best and improve it.

We are confident that there are many more improvements to come.

As you may expect, we have continued to advance our Food With Integrity mission.

For example, we have added naturally raised chicken and beef to a number of new markets.

While 100% of the pork meets our protocols, now 73% of our chicken and 46% of our beef is also naturally raised.

In April of this year, we introduced naturally raised chicken to all 64 Colorado restaurants, and we recently introduced naturally raised chicken in our Dallas market and naturally raised chicken and beef in our Omaha and Wichita markets.

Of course, we continue to work toward our goal of 100% naturally raised meat.

And just as a reminder, our naturally raised meats meet the protocols that we have set out which are humanely raised, fed an all vegetarian diet, and not given antibiotics or growth hormones.

Also, in addition to 100% of our sour cream, a majority and soon to be all of our cheese is now sourced from cows that are never given the synthetic growth hormone, RBGH.

Our customers are still not asking for this, but we are doing it because we know it is better.

From the beginning, Chipotle has been about respect and this respect started by a belief that food served fast didn't have to be a fast food experience.

We respected our customers' taste buds and their sense of aesthetics.

We allowed them to order exactly what they wanted.

We cooked food right in front of them.

We carefully selected every song we played.

We gave great customer service.

And then about seven years ago, we took that respectfulness to a new level with Food With Integrity.

Even more recently, we have revamped our people practices to empower all of our employees to be at their very best.

It is this respect that ultimately is creating a stronger and stronger bond with our customers.

All of these improvements are stepped toward our goal of truly changing the way Americans think about any fast food.

I will now turn it over to Monty.

Thanks, Steve.

Having great results is obviously rewarding and I feel really good about this latest quarter.

But, what's most satisfying is that these strong business results are flowing from doing what we believe in.

Gosh, doing what we believe in means such things as striving for Food With Integrity, as Steve already discussed.

It also means creating a culture that empowers our employees to be at their best, personally, professionally and financially.

Building this kind of culture excites us as it results not only in a better experience for our customers, but also strong financial performance for our shareholders.

We are pleased to see that our performance this quarter and year-to-date has been a result of our continued efforts to build such a culture.

At the center of any discussion about our culture has to be the restaurant manager and restaurateur position.

They are the ones who most directly and profoundly affect not only our customers' satisfaction, but also the success of our unit economic model.

Since we continue to realize that the restaurant manager is the most critical position in the Company, our first job is to identify talented crew with a potential to become managers.

Next, we need to develop them along with our existing managers so that they can deliver Chipotle's high standards in our restaurants.

Once we have done that, we need to identify and remove any obstacle that may inhibit their ability to deliver the best restaurant experience possible.

So, from the people side, our formula for success is based on these four fundamental principles, identifying talent, developing managers, ensuring high standards, and removing obstacles, and these efforts are working to develop better managers and crew.

We see this in the quality of the food served and by the great service that we are seeing in our restaurants.

We believe that this is the primary reason for our continued double digit comp sales growth.

And even though our labor percentage is much lower compared to last year, we actually have more managers per restaurant than we did last year.

These managers, most of whom are promoted from within, are more energized and efficient in everything they do.

There are serving more customers, training more crew and efficiently running a growing business while delivering better margins.

Since the last earnings call, Steve and I have spent a lot of time in the field visiting restaurants and interviewing new restaurateur candidates and what we have seen really inspires us.

First, the restaurants are clean, organized and well run.

Also, the crews are now much more aware about the career opportunities available to them at Chipotle.

And as a result, they are much more energized and excited.

This enthusiasm can be felt across the counter and improves the customer experience.

Through our latest round of restaurateur interviews, Steve and I have asked another 15 of our managers to become restaurateurs, increasing our total to around 60, and we are accepting into the program a greater percentage of those managers put in front of us.

This demonstrates that our field teams are now more aware of what it takes to be a successful restaurateur.

They are also doing a better job in identifying and training these talented people.

One way that our field teams are developing our future leaders is through what we call people development meetings.

In these semiannual meetings, our field operations teams review every manager and crew person with leadership potential.

They then agree on how to best develop each person to the next level.

Steve and I recently attended one of these people development meetings and walked away confident that our field teams are getting at better at identifying talent and ensuring these people can become our future leaders.

As a result of these and other efforts, we are seeing about 60% of our managers continue to be promoted from within as opposed to 40% last year at this time.

And our turnover rate also remains low.

In fact, it's below 30% now as opposed to about 34% this time last year.

This focus on developing managers from within is truly becoming part of our Company's culture and not just an initiative.

Our success so far increases our confidence that this is a sustainable approach to develop great managers for the future.

The recent promotions in one of our Seattle restaurants are great example of this.

When the general manager was transferred to a higher volume restaurant, the apprentice, service manager and kitchen manager were all promoted into the next position within the same restaurant.

This greatly minimized the disruption for the customers and crew, and also the crew took a great deal of pride in the fact that the people in the restaurant were trained and ready to go and take on the next level when the job opening occurs.

Another result of our continued focus on developing managers is the increase in our restaurant level margins this quarter.

Our managers are more knowledgeable and have more control, which enables them to make more conscientious decisions.

This is key to protecting and improving our unit economic model to sustain better labored and other improved restaurant level controls.

For example, our restaurant managers have ready access to detailed information comparing their restaurant to their peers in the areas of food cost, labor, people practices, and cash handling.

This information enables them to do a better job of running their restaurants efficiently and knowing where they have opportunities.

This reporting also makes it easier to identify those managers who may need additional training.

All of this leads to improved operations in our restaurants.

Service is better and our customers are really seeing this as a point of differentiation between Chipotle and other concepts.

And also, we continue to increase our throughput both during peak hours and during the 15 minute increments that we now measure.

In summary, our focus on developing great managers is paying dividends now and we believe that it will continue to do so in the future.

Better managers in every single restaurant is the key to improving operations, customer service, sales and margins.

And with that, I will turn it over to Jack.

Okay, thanks Monty.

Our culture of developing great restaurant managers improved along with our pursuit of Food With Integrity is creating an extraordinary dining experience, which continues to attract new customers and build stronger loyalty with our existing customers.

[Such] results comparable, our restaurant sales increased 11.6% for the quarter [and about] 14.5% last year, along with the 32 new restaurants opened this quarter and the contribution from our non-comp restaurant openings in '06 and the first quarter of '07.

Total revenues increased by 33.9% to $274.3 million in the second quarter.

For the six months ended in June, comps were 10% and total revenues increased 30.2%.

Our unit economic model continues to improve with average restaurant volumes now at 1,674,000 for the over 500 restaurants that have been opened for at least 12 months.

This is up from 1,545,000 at this time last year, and up from under 1.4 million just two years ago.

And Ohio commodity costs have pressured our margins this quarter, restaurant level margins still improved 150 basis points to 23.2%, the highest quarterly margin yet.

And this is a credit for restaurant managers and the talent they are developing in their restaurants.

When our restaurant managers aspire to hire and develop talent in their restaurants, and when they are getting the tool to effectively manage the business, our restaurants can support high volumes [without the] throughput, the higher cost of Food With Integrity all are providing an extraordinary customer experience and also delivering superior margins in return.

This 11.6% comp was mostly driven by increased customer visits as many new price increases to the rollout of naturally raised meats contributed only 2% during the quarter.

On the development side, we are right on track to deliver the 110 to 120 openings we guided for the year, as we opened 32 restaurants in the quarter and 50 new restaurants year-to-date.

Our development teams have done a great job in filling a strong and steady pipeline and efficiently developing our new restaurants and evenly throughout the year so far.

And these more [level-loaded] openings result in reduced stress on our system, both on our development team, but more importantly on our restaurant staffing throughout the year.

We have 640 Company operated restaurants at the end of June, including the four remaining franchise restaurants we acquired in April.

As I mentioned, restaurant operating margins improved 150 basis points to 23.2% compared to 21.7% last year, even though we lost 100 basis points in food costs.

Labor efficiencies, menu price increases related to the introduction of naturally raised meat and improved restaurant level controls were the primary drivers of the increase.

Food beverage and packaging expenses were 31.9% of restaurant sales, or up 100 basis points higher than last year due to cost pressures related to the early season freeze in California and an increase in demand for corn, which in turn has impacted many of our raw ingredients including chicken and beef.

Improved restaurant level controls over food and sales where benefits increased from being even worse.

Labor improved 190 basis points to 25.9% versus 27.8% last year due to a disciplined management of labor with the help of a national labor scheduling matrix that kind of either scaled from higher average restaurant sales and lower insurance costs now that we are self insured.

Occupancy costs were 6.7% of sales or 30 basis points better than last year and other operating costs also decreased 30 basis points to 12.3%, both of these improvements are the result of efficiencies from higher sales.

G&A as a percent of total revenue was 6.6% for the quarter.

But, excluding the $1.2 million reversal of the credit card contingency, G&A would have been about 7.1%.

We reduced the credit card [to scroll] down to zero as we have experienced almost no claims over the past several months, and any credit card that may have been compromised, we are notified at the -- when we were notified at the alleged breach back in August in 2004 have almost all expired by now.

Higher sales, along with a disciplined approach to managing our G&A have allowed us to reach this low 7% range G&A as a percent of revenues faster than expected.

Going forward, we expect to remain in this low 7% range for the balance of this year and into next.

Reopening costs were $2.6 million compared to $1.5 million last year.

We more than doubled our new restaurant openings to 32% this quarter -- I'm sorry, to 32 restaurants this quarter compared to 14 last year.

Our loss on disposal of assets increased 20 basis points year-over-year in part due to write-offs associated with the upgrading of our security system.

We have installed new systems in 150 of our restaurants for June, and we expect to install another 270 during the third quarter.

We ended the second quarter with a cash balance of about $156 million.

Net interest income was down slightly compared to last year and that is due to greater investment in tax-exempt securities.

Income from operations increased 93% to $30.7 million compared to $15.9 million last year, and our operating margin improved to 350 basis points to 11.2%.

Year-to-date, our operating margin increased 240 basis points to 9.7% compared to 7.3% last year.

Our effective tax rate was 37.8% for the quarter, as we continue to benefit from tax exempt of income and a decrease in the estimated statutory state rates.

And for the full year of 2007, we continue to expect our effective tax rate to be right around 38%.

Net income for the quarter increased by 85.1% to $20 million from about $10.8 million last year, resulting in diluted earnings per share of $0.60 this quarter versus $0.33 last year.

Removal of the credit card reserve added about $0.02 to EPS for both the quarter and the six months.

And for the first six months of 2007, net income increased 72.6%.

Operating cash flow for the first half of '07 totaled $62 million compared to about $45.1 million last year.

So, as a result of the strong comp sales in the first half of this year, we're increasing our comp guidance for the year.

We now expect comps in the high single-digits to the low double-digit range for the full year of 2007, and we continue to expect 110 to 120 new restaurants this year.

Expect development costs at right around $900,000 per restaurant.

Expect non-cash stock-based compensation in the range of $8 million to $8.5 million, and that includes just 10 months expense for the 2007 grants.

We expect dilutive weighted average shares of about $33.25 million, and over the long term, we continue to believe we can grow diluted earnings per common share at an average annual rate of at least 25%.

So, thanks for your time today.

Now, we would be happy to answer any questions you might have.

Operator, please open the line for questions.

(OPERATOR INSTRUCTIONS) We will take our first question from Jeffrey Bernstein with Lehman Brothers.

Great, thank you very much.

Two questions actually, first on pricing, just wondering if you could talk about your expectations for the back half of the year, I guess based on your expected rollout of natural meats, just wondering how much we should expect on the menu by year-end, perhaps?

And obviously contrary to prior expectations, would you now expect the restaurant level margin expansion to remain at these levels or perhaps what level do you see the restaurant level margins reaching by year-end?

Thanks.

Okay.

Hi, Jeff.

You had a couple of things, one on the menu prices.

Really, we don't really -- we don't have an expectation specifically in terms of what additional rollouts will happen between now and the end of the year.

What we can tell you though is, in the second quarter, we had a full 2% menu price increase impact for the full second quarter.

We did roll natural chicken into Dallas, and that was late in the quarter, and once that is fully factored in, we're at a run rate of right around 2.5%, 2.6%, and we expect that kind of rate of 2.5% to 2.6% to really run through the rest of the year.

And as soon as we have opportunity to roll out additional Food With Integrity meats, we will of course increase prices at the time, but really we don't have any specifics to add to that right now.

In terms of margins, there is really a lot of moving pieces with margins.

So, let me try to hit on some of them.

First of all, keep in mind that our second quarter traditionally from a seasonality standpoint is our best quarter from a margin standpoint.

We have our highest average daily sales during that -- during the second quarter.

And so, if you go back and look over the last two, three years or so, you will see the second quarter is always our highest margin.

So, I would not expect this just based on seasonality alone, our margins to remain at this very, very high level.

We still have the wild cards related to food costs.

We have seen a pretty dramatic increase in commodity costs.

We lost 100 basis points year-to-year second quarter this year versus last year.

We would have lost more frankly if we did not have additional controls at the store level and if we did not have the menu price increases, and we don't see commodity costs will leave really inside.

And so, that's a wild card.

(Inaudible) commodities continue to increase, we will continue to have pressure.

And at labor, we did just frankly a nice job of controlling labor during this quarter, and as we move into lower seasonality months from a build standpoint, we think this labor of 25.9% would be hard to sustain.

And there is about 30 basis points of non-recurring catch-up related to the fact that we are now self ensured on our health insurance that we got the benefit in the second quarter, and that's at the labor line we would not see going forward.

So, the short answer is this would probably be our high point we would expect in terms of margins and we have got a number of wild cards that we have to go up against through the rest of this year.

Great.

Next just one follow on, obviously the comp has been -- was very impressive considering most of your peers suffering significantly, just wondering if you could talk about perhaps the disparity across the country, whether there are better or worse markets obviously within that blended number?

Just wondering whether you are seeing any markets that see a pinch from consumer pressures or perhaps any sign of cannibalization or whether there are other factors that perhaps that are pressuring some markets more than others such as competition or what not?

Thanks.

Yes, it's a great question, and really our comps are remarkably consistent across the country.

Of course, they are not the same, we have some high, some low, but I can tell you that there is not one market that we look at because of economic reasons or any other reason that we see is suffering.

They are remarkably consistent, we are really having great success throughout all our markets throughout the entire country.

Tremendous.

Thanks very much.

We will go and take our next question from Jason West with Deutsche Bank.

Yes, thanks a lot, and great quarter.

I was wondering if you guys could talk a bit about what the ramp looks like on the store model, as you get into year one, two, three, have you ever given numbers in terms of comps look like as you progress in terms of (inaudible)?

We have not given specifics, Jason, but what we have said and we continue to stick to this is our new stores open up at right around 85% of our existing.

And I think the thing that we are most proud of is our existing mature stores, stores open more than 12 months is now at 1,674,000.

A year ago, it was about 1,560,000 or 1,570,000.

Two years ago, it was 1,400,000.

Our new stores have continued to open up at about 85% of that constantly increasing number, and that kind of relationship continues today.

So, we feel very good that by opening up 85%, we are within a couple of years of a reasonable comp to get up to what our average stores open 12 months or more would be at.

And then, in terms of comps, typically our new stores will comp at a little bit higher level than our existing stores.

So, they can easily close the gap from 85% to 100% within a couple of years.

Okay, that's helpful.

And just one other one, could you guys give us any color on what you're thinking about '08 store development plans?

I mean, are we looking at another year in the 20% kind of range or would it be materially higher next year?

Too early to tell.

I would say no for materially higher.

I would say that we will continue to look at our ability to build a pipeline and our ability to developed great managers.

Both of those are going well, that is why we have stepped up the development this year to 110 to 120.

We would be in a better position after our third quarter release to maybe give a range at that time.

But, I would not expect any material changes.

Okay, thanks a lot.

Next from Raymond James, we'll hear from Bryan Elliott.

Good afternoon, can you hear me okay?

Yes.

Yes, hi, Bryan.

I have a question on -- back to the sales.

One of you could update us on sort of what you saw from a throughput standpoint, particularly given that this is the highest sales quarter and also if you are seeing anything from a shift lunch to dinner, anything of a material nature going on from the day part standpoint?

Did you hear, I didn't really hear the first question.

I think the first question was one on throughput, Bryan.

Yes.

Throughput, and then lunch/dinner split.

Yes.

Well, on the throughput, we are happy to say we continue to see gains.

During the second quarter, when our sales reached higher levels, our throughput went right along with them.

And in fact, we used to talk about 90 transactions per hour sort of mid-2005, and by the time of the IPO, we were talking about 100.

And then, sometime later, we were talking about 110.

Now, we saw our transactions fill sort of another ten transactions faster over the year before, so sort of the 118 range over about 107 or 108 during the second quarter of 2006.

So, and that will be the transactions in comp stores, but during their peak hour on weekdays between 12 and 1.

So, anyway, our throughput has continued to speed up and we are delighted by that.

We are continuing to measure it in 15 minute increments as well as the hour to make sure that we are gaining efficiencies, not just in the key lunch hour, but also in dinner and in other hours during the day.

So, that is going extraordinarily well.

In terms of the shift from lunch to dinner, and dinner to lunch, no, it has remained basically constant.

We are still at sort of 48%, 49% lunch and sort of 50% -- 51%, 52% dinner, which has been the same -- roughly the same for over a year or two anyway.

Great, thank you.

Our next question will come from Nicole Miller with Piper Jaffray.

Good afternoon, great quarter.

Thanks, Nicole.

Thanks, Nicole.

I just wanted to go back to the price, and I apologize, but it was about 2% in the second quarter.

And then, what I can reconcile was, were you suggesting 2.5% for the back half of the year?

Yes, we are running, Nicole, based on everything we have done today and that includes Kansas City earlier in the year, it includes few markets late last year, the old Colorado market in April, and then we rolled Dallas and then a couple of smaller markets, Omaha and Wichita during the second quarter.

With all those fully loaded in the third quarter and in the fourth quarter, we would expect about 2.5%, 2.6% run rate.

Okay, thank you for the clarification.

Did you also mention preopening was 90,000?

It was more like about 80,000 for the 32 that we opened.

We were low in the first quarter, we were about -- typically, our average has been around 70,000 or so.

We were low in the first quarter at about 64,000, we were about 80,000 per store in the second quarter, but the two kind of average out at 73,000.

It is not unusual for our preopening to kind of bounce up and down.

That is really a function of rent.

Our cash preopening costs, that is the marketing and training, has remained constant.

Our rent is down around a little bit quarter to quarter, but for the year, for the 60 restaurants so far this year, we are right about 73,000 and that is pretty normal.

Okay.

And in terms of AUV up close to 1.7, it is often difficult to understand because it does not seem that given the rate of growth that we're not talking about maturity here yet.

So, can you pick apart either the number one unit and why, or pick whatever is a base of mature units and talk to us about their AUVs and why?

Well, it is a great question, but it is a tough question, Nicole.

I think your question deals with have we seen kind of a limit, have we seen restaurants that maybe hit a sales level and then stop, and we have not.

We have entire markets that are averaging 2.2 million, we have individual restaurants that are averaging well over 3 million, and these restaurants that are doing 3 million in these markets that are averaging 2.2 million, they look like any Chipotle restaurant that you would visit throughout the country.

And so, we don't see really a limit to what we are capable of doing with the Chipotle restaurants that we are building today and that we have built over the last several years.

A lot of it deals with just the awareness of Chipotle, it deals with the loyalty of Chipotle, some customers have -- do we just have more loyal customers, for example.

And so, we have not seen really a pattern, we see some markets that start off slower than others, but the slower markets will eventually catch on and then they will comp higher.

So, really we are delighted to say that we're seeing success in different geographies, in different markets really across the country.

There is not something that seems to be limiting us in any way right now.

That is exactly what I was trying to get at actually, and that's helpful.

And it actually leads me to ask the question then just the reverse way, if you look at those markets that you are above two, or units that you are above three and then stores that open like they would at the 85%, if you look at those markets, is there anything you just (inaudible) hurdle in those markets, meaning it has a good demographic but not a 3 million demographic or has a population, but not a 3 million population, or is it more -- I am not sure what it may be but have you looked at it that way?

Yes.

We have not seen -- I think what your question was, do we see demographics that say we should do $3 million and only do $2 million, and do we see some that say we should do $1 million and do $2 million.

I think we do look at every site, we look at demographics for every single site.

I would say, Nicole, the only thing that we see is we see sometimes a timing difference, and then in some markets where the awareness isn't as high, where the loyalty level isn't as high that may be relative to the demographic, we might be -- we might get there maybe little quickly, more quickly or little bit more slowly.

But, there has not been really a pattern.

I mean, we do great in the Midwest, we do great on both coasts, there are -- occasionally the market starts off slower, but again, based on history, our confidence is that those markets and those trade areas with the demographics we are talking about do come on strong.

I'm not sure I answered your question, I hope I have.

No, it does.

It's actually -- that's very, very helpful.

So then, the last question regarding this issue, then do you -- are you targeting new markets in a different way, are you being more aggressive with advertising to quicken that ramp, or are you okay with the ramp the way it is, which is successful?

I mean, I think the answer is we are pretty happy with the ramp.

I mean, the better it is, the happier we will be.

No, but, we're not targeting advertising in specific areas much differently than others unless we think there is some real opportunity on the local level to get involved from a marketing standpoint.

And then, my last question just as it relates to efficiencies, it is always interesting to try to digest how the margin could improve from here.

Do you consider expanding day parts or drive-through or anything of that nature at this point?

Yes, Nicole, it is, I think really important to understand that the success that you have been tracking over the past quarters, the improvements have come from being really consistent with our approach to keeping things focused and just knowing the few distinct drivers of the business and trying to make those better, and better, and better.

And for instance, I mentioned the tortilla press, which seems like an insignificant piece of equipment.

But, by making that much better and not only are we making food taste better, but we are also going to help throughput.

I mean, adding a drive-through would in my opinion probably not increase our volumes now.

We have a lot of line right now.

And so, making that line go faster, increasing throughput is really the key.

Adding the drive-through also changes the experience dramatically.

People don't view Chipotle as typical fast food for a number of reasons, the high quality of food, the interactive customer experience, the open kitchen, the environment that says something about the food, all of these things go toward creating an experience that people think is different.

And by employing traditional fast food methods of increasing the business, I don't think we are doing our customers any favors, and I don't think we're doing shareholders favors either.

Thank you very, very much, and again great quarter.

Thanks, Nicole.

Thanks, Nicole.

We will go and take our next question from Glen Petraglia with Citi.

Thanks.

Good afternoon.

I was hoping maybe you could address Food With Integrity?

Obviously you are making progress.

How long do you think it takes to get to 100% on both the chicken and the beef front?

And then, if you were to disaggregate pricing without Food With Integrity, if you just look at markets that you did not roll out Food With Integrity in the last 12 months, what sort of pricing would you be seeing there?

Well, first on, to get to 100% naturally raised meat, I mean, we will I believe -- I said it would take two years, and that was about a year ago.

So, we have maybe another year or so to go, and I think we will be there, right around there.

But, really once we are at 100% naturally raised meat, it doesn't mean we are finished investing in better quality meat, because the definition of what makes a good quality meat for us is going to change, perhaps we will want outdoor raised chicken, perhaps we will want grass fed beef, perhaps -- I don't know, there's a lot of different improvements that could be made.

So, the idea, the philosophy behind Food With Integrity is that you are never there, you have never reached the destination, you are always striving for something better.

However, to answer your question about our -- considering our protocol right now for naturally raised meats, our definition right now we should be there within a year or so.

As far as price increases --

Glen, the reality is we rarely increase prices without the opportunity to roll out Food With Integrity, and two great examples of that, when we rolled out natural chicken in Colorado this past April, we raised prices at that time.

Before that price increase, we had not raised prices in Colorado for over three years.

And it's a similar scenario in Dallas, where we just rolled out natural chicken and we hadn't had a menu price increase in Dallas for at least two or three years.

We don't think we are always going to be able to do that, but the 2.5% to 2.6% run rate that I just told you about is really the -- they are virtually over 100% associated with the rollout of natural meats in specific markets.

Okay.

And then, in terms of your occupancy costs, I think it was 6.7% of revenue this quarter.

I am curious, going forward, is there any reason why that shouldn't stay at that level or you shouldn't be able to continue to see that leverage, considering that you are growing transactions mid to upper single digits?

Well, Glen, I think you are going to expect us to see it at about that level.

But, keep in mind, just seasonality in terms of sales might cause it to bump up a few times here and there as we move to the third quarter and the fourth quarter, so just pure seasonality and I would look to previous years to see that.

The only other thing that could cause it to inch up, where we wouldn't be able to keep this number, would be if we are going into some higher price markets.

We really haven't entered Boston yet, we have got one site that's outside Boston and we think Boston will be a very strong market for us.

Occupancy costs are very high there, we are about to enter Philadelphia as well.

And so, we are doing very well in Florida and we have great opportunity there and rents are high there.

So, there is a lot of high rent markets that we have barely scratched the surface on and so, that would cause that line item to tend to push up.

And then, just lastly, Monty, just talking about throughput, if you can maybe address some of the things that you have done, obviously you are seeing very meaningful transaction count growth, I know you have done change machines and put an expeditor in, what other sort of things do you see as potential things that you can do to continue the trend?

Yes, I mean there remain a lot of things to do.

But, even though it may not be sexy to talk about this, the single greatest thing is still training and keeping better and better people.

As we -- as our -- as we pick and identify more talented crew people and as we train them to be more talented managers, these talented managers are much better at knowing what it takes to speed up our service and make our service better in all respect.

There are some things just sort of from the purely equipment side that we can do to make things faster and one that you mentioned was the change machines and that did help.

Another thing is the tortilla warmer, which Steve mentioned.

The reason it speeds throughput is it is more consistently hot and it's easier for the crew people to operate the machine.

And so, it might save a couple of seconds at the tortilla station, which is a pretty critical station for us, and allow that person to pass the Burrito on to the next station more quickly.

Likewise, we think that there are a number of ways that we can increase the speed of our point of sales system.

Not only the screen we use but perhaps even the pieces of equipment there and how we can make it more efficient, because the cash handling -- the handling of cash continues to be the slowest part of our line.

Some of that has taken care of itself to some degree because credit cards have become an increasingly large percentage of our business and they are faster than cash.

So, and that's thanks to some of our procedures surrounding credit cards such as not requiring signatures and us not waiting for verification before we can hand the card and the receipt back to our customers.

So, how we staffed that second make line, which Steve talked about, which we have called a fax line sometimes in the past, we have a second make line where we can make to go orders or orders that come in by fax or large orders from people that come into the line with a big list that they need to bring back to the office and so forth.

Our really good managers and crews will identify those people, perhaps the regulars or perhaps they can see them with a list, perhaps direct them out of the line and make their order on the second make line, which would cause the rest of the lines to move more quickly.

But, just having great crew in the right place, having really good scheduling such that all hands are on deck during our peak times so that the line is well staffed and people aren't preparing food during the lunch hour when they could have prepared it during the morning or preparing food during dinner that they could have prepared early in the afternoon, all those things speed things up dramatically.

And having -- and training our people to put everything in its place so that they don't have to make runs for paper products and so forth that they might put out before the shift, and then focusing on the 15-minute periods as well.

We used to really track this by the hour, the peak lunch hour.

And then in some restaurants, you really couldn't tell if they are improving because they would be much quicker during the first 15 minutes of that 12 to 1 hour for instance, but then they would run out of people in certain restaurants.

Well, by tracking the 15-minute hours, we are able to sort of give congratulations and support to those restaurants that are increasing those shorter periods of time because ultimately, if they do increase the speed during the shorter periods of time, they tend to get more customers as the customers are less much frustrated by the wait.

So, training more than anything but there are just a ton of little things that we can do that really continue to increase the speed of throughput, and we believe that there will be a gain -- many gains in the future, although again more slowly than perhaps they were doing in the first year.

We are really focused on this.

But, one final thing I would mention is that our customers are getting more accustomed to us.

We have more and more and more regulars and we are getting better and better and better known throughout the country and people come in knowing how to order, how to use us, and how to expedite the process.

They know that they can order by the Internet, through our DSL or through a fax phone or by telephone call.

So, a lot of people sort of figure us out and in so doing, they really help us to help speed the line.

Thank you.

(OPERATOR INSTRUCTIONS) We will go and take our next question from Mark Wiltamuth with Morgan Stanley.

Hi, good afternoon.

It's actually Scott Shapiro for Mark.

Quick follow-up on commodities, could you give any color on maybe the specific headwinds you saw from your key commodities as well as, I guess I am wondering if you have any sort of contractual protection and how long that would run for typically?

Yes, on commodities, you have three things that have the biggest impact on us this quarter versus last year, or in this order, our avocados, chicken and beef.

And in terms of contracts, we don't contract any of those items really.

Our intent is to with the meats is to try to move more towards naturally raised meats and there is really the ability to contract with naturally raised meats and so we don't have that ability.

We don't contract -- when I say contract, we have an agreement with our supplier of cheese for example, where our cheese prices, we have agreed to a fixed price for the full year of 2007.

So, of course when cheese prices spiked up quite a bit and we have not felt the impact of that as a result of those increases.

We would expect to field an increase next year when we try to renew to new agreement with them.

Okay, great.

One more quick follow-up on unit growth, you talked about [resolving] management candidates.

But I am curious to know kind of like what your pipeline is looking like in terms of target locations.

I mean is that any sort of constraint for you or is the pipeline looking pretty good in terms of your growth through '08?

We are just now working on our '08 pipeline and we are just now about to start our 2008 strategic plan or will identify which exactly markets, exactly how many restaurants, et cetera.

So, it's too early to tell.

I would say that the pipeline building for the 12 to 18 months has gone well.

That's really what's supporting our 110 to 120 openings.

That's also supporting why we are able to open more evenly throughout the year.

There is a nice healthy pipeline that we have got.

So, the pipeline is good, but it's too early to tell exactly what that means for 2008.

Great, thanks.

We will take our next question from Rachel Rothman with Merrill Lynch.

Hi, good afternoon.

Just a follow-up on the real estate question, given the soft real estate market, are you guys starting to see rental prices of real estate sites declining in price at all?

No, not at all and that's because of the markets we are in, that's because of the trade areas that we are in.

Prime real estate in prime markets are not declining whatsoever.

Okay.

And we heard from Tyson yesterday on their conference call talking about their intent to kind of enter into, focusing more on all natural chicken or antibiotic free chicken.

I realize that they are your supplier, but do you feel like having the big participants entering that market may increase the supply of more naturally focused products and thereby lower costs providing you some margin lift over the next coming years?

Well, we certainly hope so, and we applaud larger suppliers getting more interested in doing the right thing.

As the supply has extended, we have also see that there is more demand for it.

So, it's very hard to predict that there will be a downward trend in our ability to -- in the cost of naturally raised meat because of some of those -- some of those larger players getting involved.

Just as an aside question, is the price of the naturally raised meat, is that somewhat tied to the price that we would see in the regular commodity markets in a big way?

Not necessarily.

It's essentially much more stable because, on the naturally raised meat, what we are usually looking at is the cost of feeding the animals, whereas with the commodity meats, oftentimes we are talking about sort of international fluctuations and market pressures that don't affect the naturally raised meats so much because that is dealing with how much it's costing to feed the animals and of course that's affected pretty dramatically by things like the increase in price in corn and other key grains that are used for feed, but no so much on the international whims that may affect commodity ingredients.

Got you.

And then finally on the G&A, can you talk about, maybe not in any particular quarter, but over the next 12 or three years or five years, what you think the opportunity to continue to leverage G&A as a percent of sales or how we should think about where that would kind of level out or where we would begin to see less dramatic leverage in that line item?

Rachel, I would expect that G&A leverage will decline pretty significantly.

In other words, the gains that we have gotten over the last two years or so is kind of a low-hanging fruit and I think that was a significant leverage that I would expect to see level off now.

In the short and medium term, I would expect us to stay in that low 7% range, 7% as a percent of revenue.

We kind of had a goal, a communicated goal, that we wanted to get into that low 7% range within a couple of years and that would be by 2008.

And so, we got there sooner.

That doesn't mean that we expect to go much lower than that.

In fact, I would expect us to be in that low 7% range for this year and then in the next year.

I think longer-term, I think we certainly can get into the 6% and I think it's possible maybe over a three year period to maybe get into kind of that mid 6% range, if you will.

We are certainly a very disciplined Company, we are certainly very focused on putting the right G&A in this quarter business.

But, we are also 100% Company-owned.

We also put a lot of time and effort into developing our people, put a lot of time and effort into sourcing the very best ingredients.

And so, we would be very cautious not to be too aggressive in cutting our G&A to have any kind of negative effect on any of those things that we feel are very important to our business.

Great.

Thank you so much.

Thanks, Rachel.

We will take our next question from Dean Haskell with Morgan Joseph.

Thank you gentlemen.

Congratulations on a great second quarter.

Thank you, Dean.

Thanks very much.

My question goes back to the naturally raised meats.

What percentage of units currently have the naturally raised beef and then what percentage of units has the naturally raised chicken and then how much percentage has both?

I don't know off the top of my mind.

We really track it by percentage of total, and right now 100% of our pork, so a 100% of our units serve only 100% naturally raised pork.

We have 76% -- 76% of our stores is serving naturally raised chicken and 43% of our stores are serving naturally raised beef.

I don't know off the top of my head how much serve both chicken and beef, what percentage that is.

I am sorry.

Okay.

You can assume possibly that all of the beef are also serving the chicken given that differential in the positions?

No, it's not quite that.

No -- yes, it's not that way because the way -- it's important what part of the country meats come from because of distribution.

So, sometimes we may have, for instance, chicken available to a certain market, but beef not available to that market.

Another time, we will have vice versa.

So, we have markets that have all natural pork and chicken.

We have markets that have all natural pork and beef and many markets that have all three.

Okay.

And the rough differential, the percentage of price between a store that's completely non -- well, they will have pork now, but would have only the pork versus would have any one of the other combinations?

Did you ask how many of our restaurants have only pork?

The price differential --

The price differential really --

If I would walk into one that had only pork versus one that had pork, beef and chicken.

What would the price differential be?

It's $0.30 to $0.60 per item, per burrito, per burrito bowls generally, would be the difference in price.

Okay.

So, almost say 7% or 8% of the check average?

Yes, I think that's fair.

Keep in mind, Dean --

The check average is actually 9.5%, so maybe a little less than that percentage you mentioned for check average, something close to that.

And keep in mind, Dean, that's the premium that we would charge for that natural item.

But, in a market like Colorado, where we didn't have price increases for three years, [obviously] we have raised prices on everything.

And so, if you compare like Colorado just after the price increase to Dallas before their price increase, there would be differences across the menu board, but only the $0.30 to $0.60 that Monty referred to is due to the natural meats, and the rest of it would just be due to a timing difference in -- when the markets had price increases, probably things like inflation covering normal cost of doing business.

So, how much of a normal price increase are you taking in those markets?

Well, it's averaged about 7% in the markets we have recently brought naturally raised meats.

And the trends in Colorado were 10%, when we brought naturally raised chicken into Colorado, which already had naturally raised pork and naturally raised beef.

However, we added naturally raised beef just over three years ago to Denver, and did not increase our prices at that time because we had just instituted a price increase and didn't want to sort of double ding our customers.

So, we basically held off and took no additional pricing increases on the naturally raised beef for three years.

But, when we did raise prices, we raised them 10%.

The same is true in Kansas City, 10%.

A very smart move.

So, basically, you are running about 3% CPI, excluding any premium from naturally raised beef or pork, chicken, et cetera?

I mean that's probably close, I would think it's actually a little bit less than that.

If you look at over the course of the last four, five years, we have actually not kept pace with the CPI and we have fallen behind a bit, quite frankly.

But, that we're able to do that, we are delighted by that because it helps us fulfill another one of our missions which is to remain accessible, such that a broad, broad group of people can afford to go in and enjoy our food.

Sure.

And with aggressively rising traffic, you can cover those fixed costs over that base faster anyways.

Thank you very much, and again congrats on a great quarter.

Thank you.

Thank you so much, Dean.

Our next question will come from David Tarantino with Robert W.

Baird.

Hello everyone and congratulations.

Hi, David.

Thank you.

A question of the comps.

The guidance you gave last quarter suggested that you did not expect for traffic to improve sequentially from Q1 to Q2, and obviously we have seen that happen.

So just wondering what your thoughts are on what drove that.

Was it overall demand getting better, or do you think that you're driving that with some of your initiatives?

David, there is a little over 3% improvement first quarter versus second quarter, 1% of that was pricing because we took price in Colorado early in the quarter.

There is probably the other 2% remaining, part of that is momentum, maybe part of it was weather.

The first quarter, we said we didn't see an impact of weather or we couldn't measure the impact of weather.

So, it is possible maybe we did see some weather in the first quarter and we just weren't able to really calculate what that amount is.

But, for sure when you back into it, I think there is a little bit of an uptick in the second quarter.

And my main comment and I will reiterate that is I want to caution everybody not to assume that you can take a two-year comp run rate and assume that is going to give you any insight for the rest of the year.

And if you did that, you find that we did have 2% -- 200 basis points fall off into the second quarter versus the first.

And if you continued, if you thought, well gee, the two-year run rate is somehow going to be meaningful, by the fourth quarter, you would come up with some kind of comp in the 18% range or 17% range.

And so, my main thing with the caution, not to do that two-year thing that worked so well for '05 and '06, so I don't think it will work really at all in '06 and '07.

Okay, fair enough.

But, I guess a follow-up to that would be the low-end of your comps guidance assumes high single-digits and your 10% year-to-date.

So, just wondering what your thoughts are and what would cost you to be below the year-to-date run rate, especially given that comparisons get a lot easier in the back half.

Well, again, I think the comparisons are not meaningful, because that was the completion of the two-year trend '05 and '06.

We think where kind of quarters are relatively fair comparison quarter to quarter.

I think frankly, David, the 10% falls right smack in the middle of our guidance and we would hope that we would not fall to the low end of that, but we wanted to make sure that our guidance range gave us enough room for a little bit of a slip because of God knows what -- maybe weather, maybe some additional impact on the consumer.

And so, we think the range is appropriate with right now us sitting on a year-to-date basis right smack in the middle of it.

Okay, fair enough.

And then last question, on the labor line, other than the leverage that you got, what drove the improvement there and what was the size of that benefit?

I know you talked about the labor management at the store level.

How would you split out this general leverage versus some real improvement in the underlining rate?

I would say the 190, about 60 basis points relates to our now being self insured.

And of that 60 basis points, 30 of that is catch up for the first quarter, okay, and for that non-recurring.

The other 30 is recurring presuming that we can continue the good history in terms of health claims and things like that.

So, of the 190, 30 is non-recurring related to being self insured, 30 is recurring.

The rest of it, 130 basis points is some combination of higher sales and more discipline with this labor matrix.

And so, breaking that 130 basis points into which is which, hard to do.

It would probably be not too far off if you split it down the middle and sort of half was just due to having this labor matrix and half was due to having a higher sales niche, sales leverage, a kind of (inaudible) as our average daily sales increased.

Okay.

And just a follow-up to that, is there any reason why you might not see bigger improvements or just start to cycle some of the investment you have made in the new staffing structure going forward?

I would tell you, seasonality would suggest that that this would be our best quarter, and that's point one.

And then, secondly, as we have moved into the third quarter already, and we are seeing slightly lower average daily sales versus the second quarter, we have not been as effective in the third quarter so far in hitting that labor matrix.

And so, I would say that we performed very well in hitting our own internal goals in the second quarter.

And so far, we are a little bit behind that in the third quarter.

And part of that is just adjusting, it's hard to adjust when your average daily sales declined a little bit.

And so, we're working on that, our field teams are working very hard on that, but we are not going to sacrifice the customer experience, we are not going to sacrifice things like throughput.

And so, it's possible, David, that there are two forces, one seasonality and two, maybe not quite performing to our own internal goals, both of those might work against us in the third quarter.

Okay, thanks a lot.

Thanks, David.

Next we will hear from Larry Miller with RBC Capital Markets.

Hey guys.

Hey, Larry.

How you are doing?

I was trying to think about your volumes from a different perspective.

At what level do you think you are running at -- in an efficiency level that you don't want to maybe turn away customers, i.e., maybe you should be considering cannibalizing some stores, how do you guys think about the market penetration level with respect to cannibalization?

Well, I would tell you, Larry, we consider cannibalization -- we thought impact every time we open up a restaurant.

We estimate what that impact might be and we make a decision based on what we think the results would be after impact.

We don't look at a restaurant that is doing $3 million and say, "That's too much volume, let's go impact it and bring our volume down." What we do say though is, "There is restaurant doing 3 million, although there is a trade area right next to it, that we could do another restaurant that's doing 2.5 million.

And so, the very high volume restaurants suggest that we can put more restaurants near it, but it is never a consideration where we go in and say, "This restaurant is too busy, we can't handle the volume.

Let's go open up another restaurant nearby." I think it's one of the great things when we have our great managers, who are developing great people in the restaurants and we have all the right equipment and we have the right training and everything is going right.

We can handle some really pretty dramatic volume.

To give you one great example, we have a brand new restaurant in its very first week do over $70,000 in volume, and that's with a brand new crew and brand new customers.

And so, really we think we have pretty significant upside opportunities to run even higher volumes in our very high [flying] stores.

Great, that's really helpful.

Jack, can I also ask you a question and maybe it's a silly question, but in terms of stock split, I know there were some issues, as you came out from the tax-free spin-off from McDonald's, is there anything that prevents you from doing stock split over a certain time period?

Larry, it's a good question, there are some things that would make it difficult.

But, I will tell you that we are not considering a stock split right now.

We have a lot of things that we can -- we think can add value to our shareholders, that can add value to our customers.

They really revolve more around improving our ingredients, improving our restaurant design, continuing to develop great managers improve and we think stock split in terms of adding any kind of value at all is way, way, way down the list, so it's not something that is on our list right now at all.

Okay, thanks guys.

Thanks, Larry.

And we will take a question from Jeff Omohundro with Wachovia.

Good evening.

Just some questions on the prototype and building costs, just maybe you could highlight a little bit what you are seeing in terms of materials cost trends given the growth rate and the broader macro environment?

And also, I am curious about what you are doing in renewable materials as part of your design process on your prototype Thanks.

Okay, Jeff, on the cost trends, we do think that the cost inflation has leveled off a bit this past year.

And so, in prior years, we have seen inflation in the high single digits in terms of our materials cost.

This year, we have seen that maybe leveled off a little bit to more kind of the mid-single digit.

So, it's still more expensive.

But, maybe a little bit better than it had been in the prior years.

This will be our fourth year that we expect our average development costs to be right around $900,000, and we have done that through a couple of things.

One, changing our building mix, where we have relied on [that three] standard as we built the Chipotle brand and the awareness is much higher.

We have also been reducing the size of our buildings, we found that -- we think the Chipotle experience is better when you don't have very, very large buildings.

And so, we have been reducing the size of our individual restaurants and that resulted in higher average sales.

Our smallest restaurants do better gross sales than our largest restaurants.

And then just a disciplined approach to designing and constructing our building, we have been able to maintain -- really maintain the cost of our buildings.

In terms of our renewable, we have been spending a fair amount of time on things like what kind of energy use our buildings are attracting, the tortilla press that Steve mentioned earlier, it looks like that is going to consume a lot less energy than our existing tortilla presses.

We've been doing a lot of things with lighting over the past several years to try and reduce the energies with lighting.

We have had a -- we have got a couple of green -- both green buildings that have been certified in Austin by the local community there has certain green, and we are expecting to open up a -- what we hope will be [a least] certified building in a suburb Chicago, [Glenview] just outside Chicago that we hope to open up later this year or next year.

So, we have got a lot of iron in the fire there, where we are learning a lot of what green is all about, a lot of it is around energy and we expect to continue to get better at that as we go forward.

Thanks.

And with that, we will conclude our question-and-answer session as well as our conference for today.

We would like to thank you all for your participation and we hope you enjoy the rest of your day.

Thanks everyone.

Thanks everyone.