奇波雷墨西哥燒烤 (CMG) 2008 Q3 法說會逐字稿

Good day, and welcome to the Chipotle Mexican Grill third quarter 2008 earnings conference call.

(OPERATOR INSTRUCTIONS) It is now my pleasure to turn the floor over to your host, Christ Arnold, Investor Relations for Chipotle Mexican Grill.

Please go ahead.

Hello everyone and welcome to our call today.

By now, you should have access to our earnings announcement, released this afternoon, for our third quarter ended September 30, 2008, and it may also be found on our website at chipotle.com in the Investor Relations section.

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

These forward-looking statements will include projections of our restaurant comp sales trends, the number of restaurants we intend to open, food costs and other expense items, pricing plans, margins, 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 2007 as updated in our subsequent 10-Q's for a discussion of the risks that could impact our future operating results and financial conditions.

I want to remind everyone that we've 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 fourth quarter it will begin December 1 and continue until our fourth quarter release in February.

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 Financial Officer.

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

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

Thanks, Chris.

The third quarter was challenging for us.

Like many other restaurant companies, we grappled with the nations economic crisis, rising food, energy, and transportation costs, and weakening consumer confidence.

And even though we have a lot of very loyal customers in our customer base, we're certainly not immune to these conditions.

During the quarter, same-store sales growth continued to decelerate, prompting us to lower our comp estimates for 2008.

In spite of the challenges, our same-store sales remain positive at 3.1% on price increases of about 4%.

In the third quarter, our revenues increased by 18.9% over third quarter 2007 to $340 million, contributing to diluted earnings per share of $0.59, a decrease of 4.8% from the third quarter of 2007.

While top line pressure as well as increased commodity costs certainly had an affect on our performance during the period, we believe that remaining focused on our long-term vision to change the way the world thinks about and eats fast food is still the right course for us, and I am pleased to report that Chipotle has never been further along with regard to this strategy.

During the quarter, we continued to make progress in our effort to serve food made with the very best ingredients.

In addition to serving more naturally raised meat than any other restaurant company, including 100% of our pork and chicken and more than 60% of our beef, we made considerable progress toward our commitment to serve produce from local farms.

In fact, as we outlined in the second quarter, we're now serving produce from local farms in all of our restaurants when it's seasonally available.

Our initial commitment is to purchase at least 25% of at least one produce item from these farms, and if there are opportunities to purchase more than 25%, or more than one item, we'll do that.

All of this produce is coming from farms that are within about 200 miles of our restaurants, which is a sharp contrast to most produce in this country which is typically transported about 1500 miles from the farm to where it is served.

This locally sourced produce makes sense for the environment thanks to less fuel used for transportation of produce.

In addition, it supports small farmers which we believe will resonate with our customers and serve to differentiate Chipotle from our competitors and, so far, we have seen no added costs as the efficiencies from lower transportation costs have offset the reduced economies of scale from smaller farms.

While we believe that these decisions build trust among our customers in the long run, we also recognize the need to take a hard look at our business and to be sure we're connecting with our customers in meaningful ways and offering alternatives that remain responsive to their preferences.

We want to be sure that our strategies are appropriate in light of short-term pressures without sacrificing our long-term vision.

To that end, we continue to focus our attention on retooling our marketing effort and we are developing a more thoughtful marketing direction and strategy.

Over the years we have relied primarily on word of mouth and local store marketing efforts to create awareness of Chipotle, and this approach has worked well in helping people discover Chipotle as we have enjoyed 10 consecutive years of double digit same-store sales growth through 2007, but while our food and people strategies have evolved as we have grown, our marketing strategies have not.

Sure, many people are now aware of Chipotle, but our marketing can go beyond just creating awareness, building a deeper bond and a deeper sense of loyalty with our customers.

We also should expect that effective marketing can move beyond creating awareness and entice customers who have heard of us but never tried us and actually, research tells us, there may be a lot of people.

Part of this effort includes our current research, our current search for new advertising agency to help develop great creative and support our marketing vision strategy.

That process is moving forward and we are meeting with several agencies over the next few days, and we are in the process of completing a research project aimed at helping us better understand who our customers are, what motivates them, what we can do better to respond to their needs and to help us determine the best strategic platform to help us communicate with new and existing customers.

We are moving aggressively but thoughtfully so that we can make sure we make the right decision and I'm confident as ever that we're on the right track.

The macro operating environment will likely remain difficult in the coming year, but we also believe that the strong loyalty we have built with our customers will continue to help us during these difficult times, and that we will emerge even stronger when the economy improves.

We know that taking a disciplined approach to our business remaining true to our long-term vision and expanding our efforts to understand and connect with our customers remain the best way for us to grow our business and provide shareholder value in the long run.

As we discussed during our last call, we opened our first restaurant in Toronto, Canada in August.

The opening was extremely successful and the initial response from customers has been exceptional.

As expected, most of the customers have never been to a Chipotle and their reaction was very similar to how customers in the US responded when they first tried Chipotle with comments like "it's the best tasting burrito they've ever had," and that they were impressed with the quality of the food and the great service.

We also saw a good number of customers who have visited Chipotle in the US and they have been anxiously waiting for us to come to Toronto.

These Chipotle fans were the ones in line with their friends proudly telling them all about the great burritos they discovered when visiting the US.

The restaurant opened with a phenomenal management team and crew lead by one of our existing restauranteurs from Texas, Damon Biggins.

Damon and the management team, along with key support from area managers and managers from our central region, worked hard over the past several months to hire and train a great crew that not only have made us proud by creating a strong first impression in Toronto, but will also be our future leaders there.

While most of our attention remains focused on building the brand in the business in the US, we're excited about the great start in Toronto and look forward to bringing the Chipotle experience to more Canadians as we change the way Canadians and the world thinks about and eats fast food.

I'll now turn the call over to Monty.

Thanks, Steve.

As Steve said, these tough economic times make it harder for customers to afford to eat out.

Even though Chipotle provides a great value for each dollar spent, we know that some of our customers are forced to visit us a little less frequently than they were a year ago.

While these trends continue, we know that it's more important than ever to be at the very top of our game and we believe that the people culture we're building, the culture that appeals only to the highest performers, will help us continue to strengthen our operations.

The centerpiece of our people culture is our restaurateur program and the success of this program makes it clear to us that our investment in these top performing managers is paying off.

As a reminder, our restauranteurs are our top performers in every way.

They run terrific restaurants with better tasting food and a superior customer experience.

They're excellent at hiring crew and developing the crew to become future Managers.

They run great restaurants with lower turnover, lower food costs and higher margins.

Restauranteurs set the standard for every other manager for how a great restaurant should run and every single manager we have aspires to become a restauranteur some day.

For this reason, our officer team spends a significant amount of time visiting with new restauranteur candidates to be sure the people that reach this elite position embody the culture we're trying to build.

We visit potential restauranteurs along with operational directors to be sure everyone is on the same page and setting very high expectations for the taste, appearance and quality of the food, for our top notch customer service, the cleanliness of our restaurants and internal development of our crew to managers.

As we expend the restauranteur program we continue to turn good restaurants into great restaurants across the country while strengthening our bench of future restaurant managers.

To further support this special culture, in the third quarter we held our first ever all manager conference bringing all 800 of our managers and all of our field leadership together in one place.

Our primary purpose was to empower them and to ensure that they have all of the tools, training and authority that they need to build a team of high performers in each of their restaurants.

A team that will treasure each customer and ensure that each customer has a great experience every time they visit.

Our managers learned how to better interview and select top candidates, how to better develop them, and how to identify and remove low performers.

Our managers also learned how to introduce and educate new employees about food's integrity, about their career potential at Chipotle and the importance of delivering outstanding experience to every customer.

Every new hire at Chipotle now goes through this orientation before they ever serve their first customer.

The energy during this conference was amazing.

Our people came to the conference motivated, but they left the conference truly aspired and incredibly proud to be part of Chipotle.

They left the conference eager to get back to the restaurant so they could share their enthusiasm with their people and continue to work to create a team of all high performers.

We continue to see this enthusiasm in our ongoing market visits.

Morale in our restaurants is outstanding.

Our managers are proud of the high-performing teams they are creating and the people that they are developing.

They're proud of the food they serve and food with integrity.

They're proud of the great service they are delivering and they are proud to be part of a growing and successful company.

We believe this pride and enthusiasm of our managers and crew is an important competitive advantage for us.

It translates into a better customer experience and ultimately into more customer loyalty.

Building stronger teams in our restaurants has also allowed us to work toward building a stronger and more efficient mid management structure in the field.

Our mid management leaders are able to oversee more restaurants now because restauranteurs need less oversight.

In 2003 our area managers over saw an average of 5.7 restaurants.

Today, they oversee an average of 9.7 restaurants.

We are now also taking a very different approach in how we develop our people in the mid management roles.

In the past we were told one of our best managers out of the restaurant and asked them to oversee six or more stores at all once.

Unfortunately, many of them would struggle or fail in taking such a large step.

Our new approach is that the best restauranteurs will have the opportunity to mentor and oversee a nearby restaurant while continuing to run their own restaurant.

Once they're successful with the second store, they will be awarded a third and begin to mentor the manager in that one as well.

They will continue to add additional restaurants one at a time as they prove themselves successful with each.

As they successfully develop several restauranteurs themselves and as they gradually oversee more restaurants they will have the opportunity to become a team leader.

This newly created position recognizes and rewards those restauranteurs and area managers who are most successful at developing strong teams and who have a proven track record of developing restauranteurs and who oversee restauranteurs and who can oversee a patch of 12 or more restaurants.

It's our hope that soon all of our remaining area managers and many top notch restauranteurs will ascend to this new role of team leader.

But our constant efforts to improve are not limited to the changes in our restaurants.

We've always taken a practical and disciplined approach to managing G&A, including finding opportunities to streamline our corporate departments, eliminate unnecessary positions, and carefully reviewing our corporate G&A to maximize every dollar we spend.

This disciplined approach has allowed us to grow rapidly, while reducing G&A as a percentage of revenue from over 8% in January of 2006 at the time of our IPO to about 6.6% today.

And while we have full respect for the challenges of the current economic situation, we're also aware we are in a better position than most to weather the storm well.

Our same-store sales growth has remained positive in 2008 even as we have seen an economic crisis that is unprecedented in most of our lifetimes.

We are well capitalized with more than $200 million in cash and no debt.

We are able to finance our current and foreseeable future growth from internally generated cash flow, and our restaurant level economics are still among the best in the restaurant industry.

As we look to 2009, we intend to capitalize on our strength by increasing the number of new restaurant openings, by developing great managers and future leaders from within, and by making our marketing more relevant and strategic.

Before I turn the call over to Jack, I'd like to speak to the subject of price increases.

We have resisted an across-the-board price increase so far this year, largely because we know the economy is already causing so many people to make difficult choices about how and where they spend their money.

However, in light of food costs that have continued to rise further and more rapidly than we expected, we will be raising menu prices which Jack will speak to in just a minute.

While we know it may be a difficult time for our customers to pay higher prices, we remain committed to using only the very best ingredients and will adjust prices strategically considering competition, transaction trends, market demographics and other factors while still offering food that is much higher quality.

We strongly believe that this focus on improving service and the strength of our restaurant operations, combined with our commitment to serving better food from the very best quality ingredients we can find, will not only help us through these challenging times but position us for continued success when the economy improves.

With that I'll now turn call over to Jack.

Thanks, Monty.

Third quarter 2008 included a host of macroeconomic challenges including gas reaching $4 a gallon, the continued meltdown of financial sector, and the lowest levels of consumer confidence we have seen in quite some time.

While we have held up well since the economy started to soften about a year ago, the severity of the current environment made it clear we're not immune.

While we continue to deliver the very best customer dining experience we can as our restaurant managers and crew work hard to treasure and delight each and every customer, our customers are faced with the challenge of prioritizing how to spend their hard earned dollars.

Though we continue to believe we have extremely loyal customers, perhaps among those loyal in the restaurant industry, unfortunately, this current economic downturn has caused even some of our most loyal customers to visit Chipotle less often.

This, along with continued food inflation, has made the third quarter especially challenging.

During the third quarter 2008 we increased revenue by 18.8% over the prior year to $340.2 million.

Year-to-date revenue increased 23.9% to $986.6 million.

These increases were driven by new restaurants, a 3.1% increase in comps during the quarter and a 6.6% comp increase for the year.

For the quarter, the comp increase was driven by the menu price increase impact of around 4%.

During the quarter we did not seek any additional menu price increases, so the entire 4% menu price increase was rollover from increase in prior quarters.

While sales held up well in July, they decelerated in August to the low single digits and continued at that level into September and into October so far.

For the full year, we continue to expect comps within our previous guidance of mid to low single digits.

Food, beverage and packaging costs were 33% in the third quarter, up 90 basis points from 32.1% in the third quarter of '07 and year-to-date were up 60 basis points to 32.5% over the prior year.

Increases primarily due to avocados, chicken and cheese with avocados increasing more than expected in the quarter as the supply of California avocados ran out sooner than usual.

Our annual pricing agreement for rice, corn and soy have recently been renewed at levels significantly higher than last year which will cause our food cost to creep toward 34% in the fourth quarter before any menu price increases.

As we look ahead to 2009, we expect continued food inflation as our pricing agreements for tortillas and cheese expire, and from continued pressure from our naturally raised meat.

We hope the recent pull back in commodity, including corn and crude oil, will hold and reduce food inflation in 2009.

At the current level we would expect food inflation in the mid single digits next year.

So 33% food cost in the third quarter creeping towards 34% in the fourth and mid single digit inflation in 2009 would cause food costs to hit the 35% to 36% range in 2009 if we didn't increase menu prices.

This trend is what lead us to communicate in our pre-release last month that we will pursue a national menu price increase.

As you know our menu pricing strategy is typically centered around holding off increasing prices until we have the opportunity to brand additional food and integrity individual markets.

So that sometimes resulted in not increasing prices in some markets for two or even three years, mild food inflation combined with our ability to drive efficiency from our very high comps allowed us to increase margins without raising prices.

Clearly this is a different environment both in terms of food inflation and comps.

We remain as committed as ever to our vision to change the way the world thinks about these fast foods and central to this vision is our effort to constantly enhance the quality of our food even in the face of current food inflation trends and even though we already have highest food quality of anyone in or even near our category.

And we want to remain as affordable as possible, so with that in mind we have planned a fourth quarter incremental price increase of about 6%, which began rolling out to individual markets last week and will continue through the end of the fourth quarter.

The overall effective price increase in the fourth quarter, including the rollover increases in previous quarters, is expected to be about 6% to 7%.

This incremental price increase is not intended and will not fully offset food inflation I just talked about in Q3, Q4 and into 2009.

In fact, a 6% incremental price increase when fully in effect will only cover about 200 basis points in higher food costs.

This price increase is designed to preserve attractive restaurant level returns which supports our continued investment in new restaurants.

As a perspective, this increase can cover some of the food inflation, including inflation expected in 2009 and help offset the deleveraging in other areas of the P&L from the current soft transaction trends and it can result in restaurant level margins in the 19% to 20% range.

So these margins are lower than our recent margins in recent history.

Margins of about 19% to 20% are still among the highest in the industry and allow us to expect restaurant level returns in the 30% to 35% range or higher for our new openings within a few years.

While we expect over time we can return to margins in the 22% range or higher and restaurant level returns in the 40% range or higher, we need to be patient during the difficult environment and we certainly don't want to be overly aggressive in trying to retain those margins and returns at the expense of charging much higher prices to our customers.

After the price increase, our menu prices will generally be comparable to competitors even though our food quality and the value we offer to customers will be much greater.

Though we have seen little or no resistance to menu price increases in the past, we recognize this environment is much more challenging and we hope our customers will understand and respond favorably.

Labor costs were 26.3% of revenue in the third quarter of 2008 which was flat compared to the same quarter last year.

Despite decelerated comps, a slight deleveraging in management crew labor was offset by better workers comp experience for the quarter.

Year-to-date we saw 30 basis points of labor leverage and as we've lapped our labor measures early this year, we continue to expect no labor leverage for the remainder of the year.

Occupancy costs for the quarter were $24.5 million or 7.2% of revenue up from 6.9% last year, and year-to-date occupancy costs are up 20 basis points to 7.1%.

As we discussed on last call, occupancy costs as a percent of revenue were up primarily due to the opening proportionally more restaurants and in more expensive densely populated areas such as Boston, New York, Philly and Florida.

Other operating costs for the quarter were 12.2% of revenue up from 11.6% in the third quarter of '07.

Year-to-date, these costs are 12.4% revenue up from 12.1% in 2007.

While other operating is down 40 basis points from last quarter driven by reduced marketing and promotional expenses, it is up over last year due to increased facility and higher maintenance and repair costs.

Our G&A expenses were $22.6 million for the quarter or 6.6% of revenue, down 10 basis points from the same quarter last year.

The expenses for our first ever all managers' conference held in August we discussed in the last call were offset by a reduction in our 2008 bonus accrual.

For the year, our G&A is at $64.9 million or 6.6% of sales down slightly from the same period last year.

We continue to expect slight to no G&A leverage for the full year.

For the quarter, income from operations was $31.1 million which is down 1.1% from the prior year and year-to-date income from operations is $96.2 million up 19.1% from last year.

We ended the quarter with a cash balance of $212 million.

With the onset of financial crisis and a lack of confidence in traditional liquid bank held investments, we became increasingly more conservative with investing our cash, investing much of it in US Treasury to ensure capital preservation.

Combined with lower interest rates in general compared to last year, interest income for the quarter declined 30 basis points to $931,000.

For the year, interest income is $3.2 million, also down 30 basis points from the same period last year.

Part of this capital preservation strategy entailed us moving away from tax exempt security and, as a result, our effective tax rate increased to 39% for the quarter.

The tax rate impact in the fourth quarter will remain dependent on the stability of the financial sector and confidence in investing in tax exempt securities.

For the quarter we opened 20 new restaurants which included our Toronto opening.

With the 20 new openings for the quarter as of September 30, we now serve customers in 798 restaurants.

Given our strong real estate pipeline and cash flow position, we remain confident in our guidance of 130 to 140 new restaurants for 2008.

Our shares outstanding as of quarter end decreased to 33.17 million as a result of the impact of lower average share price on stock options included in the fully diluted shares calculation.

Despite difficult credit markets in a challenging economy, Chipotle's strong balance sheet and operating cash flow allow us to act opportunistically.

We will allocate up to $100 million or roughly half of our existing cash balance to repurchase B shares under a 10b5-1 open market purchase plan.

Additionally, due to our strong restaurant level of returns, we will invest in opening 135 to 145 new restaurants next year funded by operating cash flow and, frankly, we have a top performing development team with a capacity to open even more new restaurants next year but we have begun to see a slowdown in new development which we expect will reduce or delay some of our inventory for 2009 openings.

Now that we are past the second anniversary of our separation from McDonald's we are assessing the possibility of collapsing our dual class structure.

It's important to understand that we face significant and complex hurdles which we may not be able to overcome.

In order to take any action to modify the separate classes, we have to receive an opinion of council acceptable to McDonald's or work with McDonald's to receive a ruling from the IRS that a collapse of the two class structure won't compromise the tax-free nature of the split-off to McDonald's and its shareholders.

We can't make any guarantee that either of these routes will be available to us and we took any action violation of these requirements and even if we do meet these requirements and the transaction subsequently deemed taxable to McDonald's shareholders, we could face liability to McDonald's that we estimate could be as high as $400 million to $500 million, so obviously we need to honor our contractual obligations and not make any decisions on the dual class structure that could adversely affect our shareholders.

So the best we can do at this time is to assure you we'll pursue this as far as we can on behalf of our shareholders and we'll make any announcements as soon as we can.

We typically ended our calls with comments about our long-term growth expectations which we state as targeting a growth rate of at least 25%.

We still believe we have the ability to grow at this rate in the long term, but we don't expect to be able to achieve that growth rate while the economy and consumer are under so much pressure.

As we gain more clarity and visibility around the financial markets the economy we will have a greater confidence as to when we can return to that rate of growth.

In the meantime, we'll continue to focus on our vision, and continuing to grow the Chipotle brand and the business in a strategic disciplined manner.

Thanks for your time today.

We would be happy to answer your questions.

Operator, please open the line.

(OPERATOR INSTRUCTIONS).

Our first question today is from David Tarantino with Robert W.

Baird.

Hi.

Good afternoon.

Just a clarification question on the mention of the trends to date in Q4.

Jack, did you indicate that comps were still positive?

Comps are still positive, David, and they are in the very low single digit range.

If you think in terms of the third quarter we had comps overall of 3.1% an that's made up of a pretty healthy July.

We held up well in July and we had our second quarter call at the end of July and didn't have any idea that this trend was about to happen, so we saw the trend decline in August to low single digits and we saw basically that new level continue into September and into October.

So to hit the average of 3.1% for the quarter knowing July was pretty healthy, the idea we were in the pretty low single digits but still positive, David, on a sales basis.

Okay, and then a follow-up to that.

In terms of all of the commentary on margins, which was helpful, what type of traffic assumption is embedded in that commentary, Jack?

Is it in line with what you've seen recently or worse than what you've seen recently?

It's generally in line, David, and because this is a new environment in terms of our customers accepting price increases, I would assume and we have assumed pretty conservative assumptions on what kind of resistance we would see.

Our history had shown that we see little or no resistance, but this is a different environment, so we remain relatively conservative on how our customers can absorb this increase.

Great.

Thank you.

Thanks David.

Our next question today is from Jeff Farmer, Jefferies & Company.

Great, thanks.

One quick question for you.

Jack, can you just remind me how your protein cost pricing structure works with your suppliers and I guess, more specifically, is there a historical relationship we can look at between your actual protein costs and movements and things like corn and soy?

Yes, Jeff.

You can think of our relationship with our suppliers generally be on a spot market basis.

We do have pricing relationships that may go for as long as a quarter, but it's generally not locked.

There isn't like the feed cost, for example, locked.

We are working with our suppliers and we've got many smaller suppliers to try to do that to try to work with them so they can lock the cost of their feed so we can have more stability.

Generally, Jeff, we will see the cost of our naturally raised meats move with the cost of feed so as corn moves up and down it will move.

It just doesn't move as abruptly so when the feed moves up, our costs do move up but just not as abruptly as the commodity markets, and same thing in terms of when it moves down and there's one fundamental difference that we see with, for example, the cost of our naturally raised chicken compared to commodity, there's some unnatural situations in the commodity chicken environment where chicken prices have been coming down, commodity chicken price has been coming down yet chicken suppliers are losing money, going bankrupt and it's not a sustainable model.

Our model is more sustainable where our suppliers need to make money and so to the extent that the feed cost is going up or to the extent feed cost remains high, even though it's pulled back, our prices have not come down, our naturally raised chicken price did not come down really anywhere close to what the commodity chicken has.

Ours have really held up.

Just as a follow-up to that, the natural question is have you seen any of your network of suppliers be pressured or get to a bankruptcy point?

No.

We've not seen any indication of that kind of pressure.

Okay, and just one quick clarification.

You said 19% to 20% restaurant level margins in '09 and that includes the benefit of 6% pricing right?

It does.

Okay.

Thank you very much guys.

Thanks Jeff.

Or next question is from John Glass, Morgan Stanley.

Thanks.

First, Jack, just as a follow-up on your comments about the 25% earnings growth long term.

Is it possible or even probable you won't see any earnings growth next year given your comments about restaurant level margins?

I think in this environment, John, I think you have to consider anything is possible but if you go through your model and you take kind of the margins we're talking about, the kind of openings we're talking about and accounts we're talking about and with some slight G&A leverage, I think you'll see that we should have the ability to grow our earnings.

I just don't think it's possible for us to, with confidence, say that we can get to that 25%.

At least not until there's more clarity, visibility with the economy.

Okay, and does that include the buyback you announced tonight or that would be on top of that benefit?

Well roughly it includes it, John, but that's contingent upon we're going to do open market purchases, there's a limit to how much we can buy and, as you know, there aren't that many shares being traded so it will take time, so it's in there but it's just a matter of your assumption in terms of how quickly we're going to be able to buy the shares back.

And then as a practical matter, why does it matter you could lapse the shares rather than just buy B's back since it's economically more a benefit to buy the B's?

Why even consider the risk of collapsing the shares?

Well, it doesn't help us run our business at all, but we have many shareholders, in fact our largest, most of our largest shareholders have a significant ownership in the B and so we owe it to them John and we think we can do this in a non-distracting way.

We can have attorneys look into it, and we won't do it if there's a risk.

We have to do it with pretty much 100% certainty that we won't trigger this tax problem.

If we're able to do that, it's a benefit to our B shareholders, it removes a potential distraction as some of our shareholders are concerned and sometimes confused because none of us really understand why there's the gap in the B's and frankly all of our shareholders benefit because if the B 's do convert to A's we have much more liquidity and I think that's probably better for all of our shareholders.

Thank you.

Thanks John.

Our next question is from Jeffrey Bernstein with Barclay 's Capital.

Great, thank you.

A couple of questions.

First one just primarily related to unit openings.

Just wondering the targets you put out for next year, whether you contemplated more or less.

I know you made a comment with regards to slowdown in development that was going to impact your growth.

I'm just wondering if you can give some details on the new construction environment, the terms you're seeing and kind of how you arrived at the number you did, and then I have a follow-up.

Thanks.

Yes, Jeff, our inventory building through the first half of the year was going great and we were on target to really shoot for a greater opening number than the 135 to 145, but over the last couple months, we really started to see that development, new developments are slow to come out of the ground.

We've had a couple that look like they're still real deals but they aren't going to get done in 2009.

The developer, either because of financing problems or just a little bit of a hesitancy, some of those deals will be pushed off.

So really I would say most if not all the fact that we're opening fewer than we're capable of opening is because of outside forces because of the economics.

We also are starting to see a little bit of room to negotiate some of these deals, to get some better terms including some better financial terms.

It's not always the case, and when you are dealing with a new development the landlord needs to attract certain rents so he can justify really starting to building in the first place.

Those are much, much tougher to find some negotiating room and to improve the terms but in general we're starting to see some relaxing of the terms and we're fortunate that we're one of the few companies out there that are still growing.

Got it.

And then just on the pricing, I think you said the pricing for the fourth quarter is in the 6% to 7% range based on when you're implementing the 6% increase.

Just wondering when you lap the prior 4% as you look to early '09, are we looking at 6% or is it going to fall off over time?

Yes, it will fall off over time, Jeff, and probably the best way to think about it is of the 6% to 7% that we expect to see in the fourth quarter, roughly half of that is rollover from previous quarters, roughly half of that is incremental in the quarter, okay.

And then as we get into January, we have basically in that same kind of 6% to 7%, maybe 8% range for awhile and then gradually the prior quarter is going to fall off and after, it's in about three or four months into 2009 you basically got the 6% I talked about as the incremental.

Got it.

And then just on the commodities I think you said Q4, or actually you said mid single digit inflation in the third quarter.

Just wondering whether you have kind of, I know you said a lot of it is on spot market but if things remained where they are right now kind of what your expectation for inflation in the fourth quarter and bigger picture what it looks like for '09 at this point in terms of inflation basket?

Yes, well, this is just to clarify.

In the third quarter we talked about food costs were 33% and I don't know if I quoted what inflation was, I haven't really calculated that.

We see our food cost in the fourth quarter moving up towards 34%.

That's mainly the three items that we have been talking about on a few calls now, that's because of rice, corn for the salsa and soy oil, so we see food costs in the fourth quarter approaching 34%, so that would imply a 3% bump from the third quarter and into 2009 we see another mid single digit kind of inflation in 2009 and that's where we talked about the fact our food costs without an incremental menu price increase would be approaching that 35% to 36% range.

Okay, and then just lastly in terms of the average check, wondering if you have any fear of pushback on traffic with aggressive pricing?

I know you held off on taking pricing for as long as you could, but whether or not there are any test markets or anything you can look back on to give comfort that you're not going to see further traffic fall off with kind of more aggressive pricing pushing people the average check?

Well, despite the fact we haven't raised prices for quite a long time or I should say in our average store, our average store has not experienced a price increase in 20 months, so with that in mind, what was my point, we wouldn't have made those price increases we did not notice any resistance.

We noticed no fall off in traffic whatsoever, but the reason Jack made the comment that we're more cautious now is just because in light of this environment and this economy, we are not going to go ahead and predict we will have absolutely no resistance again, so we're a little more careful to predict that.

But a key part of our philosophy is to make our food accessible so we've always taken a hard look before raising prices and we continue to lag behind the CPI in doing so and, in fact, even during this time of high food placement we've got very few price increases.

So we are committed to making these much higher quality ingredients available and accessible to serve everybody and to continue to make our food affordable and so that's the reason for increasing prices at this time.

But we do not predict that there will be no resistance, but we've got confidence that our customers understand that we haven't raised prices and we've been very hesitant to do so, that they understand our ingredients are better, that they are very loyal, and that they will understand our doing this.

So we were cautiously optimistic that this will be well received.

Great.

Thank you for the color.

Thanks Jeff.

Our next question is from Steven Rees with JPMorgan.

Hi, thank you.

Just wanted to explore the comp deceleration a bit.

If you think about some of your older more mature markets versus some of your newer units and newer markets that maybe opened up two or three years ago, have you seen any difference between the same-store sales performance in these two different markets or are they all sort of slowing down together?

You know, Steve, we have seen a difference really in all layers of openings, and you've heard us talk about before if you go back and look at the layers of openings, typically our newest restaurant has the highest comps.

The next layer of openings has lower comps and the older you go, the lower the comps but even in this environment of low single digit comps, our oldest stores that are five years old and older are right at about flat from a sales standpoint.

That doesn't mean they are on average negative from a transaction standpoint, but they are relatively close to flat, when our comps are in a very low single digit range.

And then our newest openings, those openings from the last few years, they're still healthy positive comp.

They used to be healthy, well into double digits.

They aren't into double digits anymore but they are well into the single digits, so they still have that stair stepped as you go to the older opening, but every single layer of opening including our oldest, including our newest have moved down.

Okay, and then historically you've talked about where the new store volumes have been coming in.

Has there been any change there in the more recent openings?

Yes, Steve, I would expect the same kind of mix as we talked about on the last few calls and that is about one in three of our openings will be in what we describe as new or newer markets.

We expect that to really continue for the rest of this year and into 2009 based on the inventory we built so far.

Okay, and then just finally I guess for Steve, you talked about kind of exploring new marketing strategies in '09 and sounds like you want to be more explicit with the message and you create to drive traffic.

Can you just give us more color of the types of things you're looking at, if you think you're going to break from traditional print and billboard media?

Well I wouldn't necessarily look at it that way.

We haven't decided the tactics of what kind of media we would be using.

Traditionally though, our message has been generally around brand building and focusing specifically though on local store marketing and just introducing awareness of the Chipotle brand.

We now know that people are very aware of Chipotle.

Now we're specifically going to build stronger relationship with our customers by talking to them about what differentiates us from the competition and other fast food, specifically why the quality of our food is better and why the taste of our food is better.

We want this to be able to show increases in transactions directly, so it's going to be a much more sort of aggressive way of talking to our customers specifically about why we're better.

We've always been a little bit hesitant to do that and we think that now is the time to share how special the Chipotle story is.

Okay, great.

That's helpful.

Thank you very much.

Our next question is from Jeff Omohundro with Wachovia.

I just have two but just as a follow-up to that question that was just asked, it sounds like that's a further evolution of brand awareness.

I'm just wondering if there's going to be more explicit efforts to drive existing customer frequency and how you might weigh that versus driving a new user trial.

Well, I think it will be both and how that breaks down, I'm not sure.

I think it's too early to be able to make those kinds of predictions but, again, our initial marketing was more of an awareness building and we noticed that we have great awareness.

Now we want to specifically drive people in in two ways, to your point.

new customers and by strengthening the bond with our existing customers get them to come in more often and we can do this, we think, by taking an approach that lets them know why we're different, specifically that we are buying better quality ingredients, sustainably raised ingredients and there are many different reason these ingredients are good, and we'll show the direct link between that and that creating better tasting food.

And how soon do you think you'll be able to share with us your thoughts in terms of the spend rate either in a dollar amount or as a percentage of sales to support these new efforts?

Well, we don't anticipate increasing the percentage that we're going to be spending on marketing but, instead, the moneys that we spend will be very focused on specifically creating marketing that will drive people in by doing the two things, creating the stronger bond with existing customers and bringing in new customers who may have been aware of Chipotle but haven't really thought or haven't had a reason to actually try it.

And just on one other last topic, given this challenging macroenvironment and considering the 135 to 145 unit development target contemplated for 2009, I'm just wondering in the event that the environment continues to be challenging or perhaps worse, just how locked in are you on those targets and could some flexibility maybe push some out into 2010 if that seemed prudent?

Yes, Jeff, I mean, based on what we know today we don't see that being necessary but I guess the nature of your question, there's inventory that we built and that we committed to and that we have broken ground already, obviously those are committed to.

I would say for roughly half of next year, it's fully committed.

We've got a signed lease, we've done the due diligence, we're ready to go on those things.

In the second half of the year, not only could we if we chose to maybe get out of a deal that's possible but we don't anticipate doing that but, as I mentioned before, it's possible the developers who we are counting on to deliver space to us in the second half of next year that we might get open, that they may not be able to do so or they may not get the financing so they just slow their whole development.

But just as another counterpoint of reference, we've already through three quarters generated $150 million of cash this year.

We generate a lot of cash and a lot more cash and our EPS suggests because of things like the deferred rent that you're able to get in our 10-K when you look at the statement of cash flows.

Stock option expenses is not cash generating, so when you look at our statement of cash we generate a lot of cash notwithstanding the EPS that we are reporting, so we fully expect with that opening total to more than fund those and have cash left over.

Very good.

Thank you.

Our next question is from Jason West with Deutsche Bank.

Yes, thanks.

I believe you guys mentioned that the food margin would be in the 35% to 36% range in '09 without pricing, but could you tell us roughly what it might be or what it might look like if you include the pricing that you're going to take?

Yes.

That 6% incremental that we are talking about, Jason?

Yes.

Will cover about 200 basis points of food costs so if you take the 35% to 36% range, assuming all projections are correct, not 200 basis points off that and that's what the price increase, I'm sorry, yes, that's about what the price increase will do so at the end, the 33 to 34 range.

Okay, and then just a bigger picture question on the margins.

You guys did run restaurant margins at the high end of the industry even though you're a fairly young company, just what is the reasoning?

Why do you think this model should continue to support those margins over the long term in a pretty competitive market and would you weigh that versus holding on to market share and traffic, maybe take some off of the premium margins that you have today?

Well, I would, Jason here is the way I would answer why this model works and why we're able to enjoy the margins we are.

We have driven the large part of that margin or a big part of that margin.

It's a very focused model.

We have not changed the menu, we have not thrown gimmicks at our operating team so we've been able to run extraordinarily efficient labor, extraordinarily efficient food cost, we can manage our food cost and this is all while we're preparing all this great food.

Our crews come in and our managers come in very early in the morning to prepare all this food and yet because we're so focused we can be very, very, very efficient.

We have not been funding these attractive margins by really high menu prices.

In fact, we are funding basically the ability to go out, buy this very expensive, very high quality food, and basically charge about the same price as other competitors within this category.

So if you look at other fast casual providers, look at their menu prices versus us and this is after the menu price increase that I'm talking about, we are out of par with them, yet if you look at our food costs, our food costs are much much higher, our food quality is much much greater than any of those competitors.

So we're offering our customers a much better value by buying this high quality, premium food and charging the same prices so we've earned these high margins by basically starting with and then protecting a very efficient unit economic model.

Okay, thanks.

Thanks, Jason.

Our next question is from Sharon Zackfia with William Blair.

Hi, good afternoon.

Jack, it looks like your new unit productivity kind of came in actually in line with what you've been seeing for so long after having beaten that as a percent of comp sales I think forever and I'm just wondering, have you seen that stabilize, has it continued to run at that 85% of comp sales as we got into September and October?

Well, it's not in the 85%, Sharon.

It's more in that kind of below 80%, 75% to 80% or so that we talked about on the last two calls.

From a dollar standpoint, I've been talking about on average it's between $[1.350] and $[1.4] million on average and is staying right within that range so you're right to observe that.

The openings are still hanging right in there and we're delighted by that because that causes, that along with the expectations of these margins in the 19% to 20% range in spite of food inflation and with the menu price increase, allows us to invest more of the capital in opening up the next round of openings.

Okay, and then secondarily, now that you're projecting if you add up all of the components slightly slower sales growth in 2009, how should we think about the dollar growth in your G&A?

Is that going to settle more kind of in the mid teens going forward or I know you're expecting leverage but I'm trying to figure out what the right dollar run rate is at this point for your Company.

Well, you know, I haven't thought about it that way, Sharon.

What I would do and I know you can back into the number is I would expect that we could hopefully see some slight G&A leverage.

We saw extraordinary leverage the year we went public and last year we saw some nice leverage as well.

You won't see that again, but we do hope that we'll see maybe 10, maybe 20, slight G&A leverage in that kind of range.

No, of course, it depends on a lot of factors.

It depends on what our sales really do, what happens with the economy, wage inflation and things like that but we've always managed our business in a disciplined way.

We don't feel like we have to all of a sudden become disciplined because the economy is tough.

It's just who we are and what we do, and so I think we can inch out a little bit more G&A leverage into next year and hopefully each year, but it will be inching it out rather than taking big bites of G&A leverage.

Lastly, just to clarify, if comps so far in October are running kind of in the very low single digit range, should we expect it to be a little bit better for the full quarter as you take the price?

It all depends on how well our customer will absorb the price increase.

We're remaining cautious and we're assuming our customers are going to struggle with this a little bit, yet the facts we have on our side is typically our customers have not seen, they've generally have not resisted, offsetting that though is a tougher environment.

This is the toughest environment we've ever taken a price increase in and so we're being very cautious about that, Sharon, and we're assuming we'll probably stay in that same very low single digit comp level even with the price increase, but that remains to be seen.

We took the first price increases.

In fact, we saw your note on it last Friday, so this is we're really just days into it.

Well good luck.

Thank you, Sharon.

We have time for two more callers.

Our next question is from David Tarantino, Robert W.

Baird.

Hi.

Just a follow-up, Jack, on a couple line items.

Pre-opening costs looked a little high relative to the number of units that were open in the quarter.

I was wondering if you could help us understand what's going on there.

Maybe it was the entry into Toronto, but was there something else going on there?

No.

It wasn't really Toronto much at all, David.

The way I look at it is look at the pre-opening costs more on a year-to-date basis because we only opened 20 restaurant the during the quarter but we have a lot in the pipeline because to meet our range of 130 to 140, we'll have more openings in the fourth quarter and we got a bunch keyed up for the first quarter of next year as well, and so pre-opening costs we're starting to incur those on that store to have not yet opened.

Now if you look on a year-to-date basis, it's in the $94,000 per store range.

That's a little higher than we typically seen.

We typically seen more in the $80,000 range, but when you look at the 94, two-thirds of that is non-cash.

So we're not really spending more cash on these openings but because of the straight line rent calculation, because of some of these higher occupancy cost markets we're going into, we have to book a journal entry that goes to that's recorded to the reopening expense, but two-thirds of that number is non-cash, David.

It's not economic.

It's another reason why we're able to generate as much cash as we are despite the EPS that we report.

Okay, thanks and then the other line item asset disposal loss, it looked like that was up a million dollars sequentially.

Was there something going on there that made that higher or is that the run rate that you would expect going forward?

It's really more, David.

We just been a little bit more aggressive throughout the year in looking at our older stores and upgrading, doing some remodels in those stores so write-offs and just a little bit.

Denver is one of the markets in particular that we really take a look at it, by far our oldest market so we've done some things to spruce it up.

We've changed, we've got a new great looking counter that displays our food in a much better way.

Our food just looks better with greater visibility with this new counter so we think some investment in some of our older restaurants and we had to write-off some of the older assets.

I would expect that that was a little bit of a bump up and we should probably retreat back to kind of a normal run rate like you have seen in the past.

Okay, thank you.

Thank you, David.

Our last question comes from Nicole Miller with Piper Jaffray.

Good afternoon.

I might have missed it, Jack, but what was the cash balance at quarter end?

$212 million.

And CapEx for '09, is it the same as '08?

We haven't communicated that but it will be in the same ballpark, Nicole, because our openings are in the same ballpark as well.

I might have missed this as well, but why are you buying back only the B shares?

Because they are on sale.

Okay.

That's all I had.

You know what, and every time we buy one of those we are buying 10 votes, so clearly it's just economical.

We could buy a lot more shares with $100 million by buying the B's than we could if we buy the A's.

All right, thanks much.

Thanks Nicole.

I'd like to turn the call back to Chris Arnold for closing comments.

Thank you, all, for your time today and we'll look forward to speaking with you next quarter.

Thanks everyone.

We thank you for your participation on today's call, and have a wonderful day.