奇波雷墨西哥燒烤 (CMG) 2011 Q2 法說會逐字稿

Good afternoon, and welcome to the Chipotle Mexican Grill second-quarter 2011 earnings conference call.

All participants are in listen-only mode.

After the speakers' remarks, there will be a question-and-answer sessions.

(Operator Instructions).

As a reminder, this conference is being recorded.

Thank you.

I would now like to introduce Chipotle's Director of Investor Relations, Mr.

Alex Spong.

Please go ahead.

Thanks, Justin.

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 of 2011.

And they also can be found on our website, Chipotle.com, in the Investor Relations section.

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

These forward-looking statements will include projections of the number of restaurants we intend to open and restaurant returns; comp restaurant sales increases; food cost trends, and the impact of major price increases and operations initiatives, as well as statements regarding regulatory matters and other statements of our expectations and plans.

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

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

We refer you to the risk factors in our Annual Report on Form 10-K as updated in our subsequent Form 10-Q's for a discussion of these risks.

I would like to remind everyone that we've adopted a self-imposed quiet period, restricting communications with investors during that period.

That 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 1 and continues through our third quarter release in October.

On the call with us today are Steve Ells, our Chairman and Co-Chief Executive Officer; Monty Moran, Co-Chief Executive Officer; and Jack Hartung, Chief Financial Officer.

With that, I'll now turn the call over to Steve.

Thanks, Alex.

Our topline performance for the second quarter remains strong, with a revenue increase of 22.4% to $571.6 million over the same period last year, due largely to strong new restaurant opening volumes and a same-store sales increase of 10%.

However, the quarter was also challenging in many ways, with our margins under pressure, food inflation picking up, and the US Attorney's Office entering the immigration investigation in April.

But just as we remained focused on the things that will create the best possible dining experience for our customers when we were at the height of the recession, we are continuing to spend the vast majority of our efforts on these things now.

It's clear to us that serving better tasting food made from more sustainably raised ingredients, and building a people culture that will delight our customers while developing future leaders from our crews, will allow us to continue to grow our business.

Our focus on doing these things better than anybody also will help us ensure that we will continue to provide long-term value for our shareholders.

One way we continue to make our food better is to constantly seek out produce where our restaurants are located, i.e., locally grown produce.

And this year, we have increased that goal by targeting at least 10 million pounds of produce from farms that are within 350 miles of our restaurants.

This goal is in stark contrast to most produce served in this country, which typically travels about 1,500 miles.

Ultimately, our use of locally grown produce allows us to serve fresher, better tasting food, while also supporting local family communities all across the country.

We are also making progress on increasing the rollout of our brown rice to all of our restaurants.

Right now, we have brown rice in about 140 locations, including all of our restaurants in Philadelphia, Boston, Denver, and Austin, and select patches in Chicago, Phoenix, and Seattle.

We are extremely pleased with the taste of the brown rice, which has a subtle, delicious nutty flavor, and we're very pleased with the significant nutritional benefit it offers.

Just as we do with the white rice, we season the brown rice with fresh citrus juice and cilantro, so its flavor is similar to the white rice we have always used.

We can see that our customers really appreciate the choice of brown rice and it is proving to be very popular.

We're also getting better at educating our customers about Food With Integrity and our commitment to serving food that is raised with respect for the land, animals, and the farmers who produce it.

We began this effort last year with our Straight Talk campaign, and continued it this year with a campaign we called Unlimited Time Only.

Both of these efforts were designed to communicate our never-ending commitment to serving food made with ingredients from more sustainable sources.

The good news is that these efforts are helping to influence customers' appreciation of Chipotle.

Based on our most recent marketing research, the Unlimited Time Only campaign broke through an incredibly competitive category, and successfully communicated the story of our better ingredients.

Through our marketing -- though our marketing does not follow the traditional restaurant advertising playbook, our campaign helped to positively reinforce the perceptions about Food With Integrity, which began with last year's campaign.

Specifically, advertising awareness is up 19% over all, and unaided brand awareness increased significantly, up about 25% in markets where we concentrated our campaign.

Loyalty and preference for Chipotle also increased significantly over the course of the campaign.

We continue to believe that the more people understand about our commitment to serving food that is raised in a better way, the more it will deepen their trust in Chipotle, and increase the likelihood that they will eat at our restaurants more frequently and bring in other people.

Results from this campaign are encouraging, indicating that our message is breaking through, and awareness of Food With Integrity as well as loyalty to Chipotle are increasing, as evidenced by our double-digit sales comps.

We are now in the process of rolling out our first-ever Affinity program, which we call the Farm Team Program, which we think will further educate customers and encourage them to share their knowledge of Chipotle with their friends and families.

Unlike a typical restaurant loyalty program, which is generally something like a "Buy 10 and Get 1 Free" program, ours is aimed at rewarding people for their understanding of and passion for Chipotle.

The core of the Farm Team Program is an online world that shows the full spectrum of farming, from very industrialized farming to more sustainable methods.

Farm Team members will have the opportunity to learn where their food comes from and how it is raised; to take quizzes; play games; participate in polls; and watch videos to learn about Chipotle's philosophies regarding food that is raised right.

Participants can earn badges and share facts using Facebook and Twitter.

As customers make their way through the Farm Team site to different levels, they earn points, which they can exchange for food and other prizes.

Initially, participation in the Farm Team will be limited to those who are invited by our restaurant managers and local store marketing and customer service teams inviting most of the loyal customers and -- most loyal and passionate customers to participate.

With this focused approach, we think Farm Team will prove to be a valuable tool to help our best customers become evangelists for Chipotle.

This kind of word-of-mouth marketing has always been important to us, going back to the very first restaurant, and has contributed to the growth over the years.

But it should be even stronger as we harness it in this way.

Eventually, the program will be expanded to include more customers.

Lastly, we are moving closer to opening our next restaurants in Europe, with plans to open our first restaurant in Paris in the third quarter, and a second location now under lease in London.

And we are moving towards the opening of our first Asian restaurant, ShopHouse Southeast Asian Kitchen, which will open in Washington, D.C.

late in the summer.

While we do not expect our European expansion or ShopHouse to be near-term drivers of our growth, we're providing the foundation for the future with these growth options.

Of course, our focus for the foreseeable future will be on the continued development of Chipotle in the United States.

I'll now turn the call over to Monty.

Thank you, Steve.

One of the things I'm most proud of at Chipotle is this drive that we all have to constantly raise our standards, our desire to get better at everything we do.

We work constantly to improve the quality and the taste of the food we serve, with better ingredients, better equipment, and better cooking techniques, ever since Steve opened his very first Chipotle about 18 years ago.

And because our food culture is as strong as it has ever been, I know that our food is going to continue to get even better.

One of my primary objectives since I joined Chipotle was to help build a special people culture that matches the very special food culture that we have.

Nothing is more satisfying than visiting a restaurant with a team of all-high-performers who are energized and empowered to achieve high standards, and deliver a special dining experience to each customer who visits.

Our teams in these restaurateur restaurants describe their co-workers as family, and they describe their experience at Chipotle as inspiring and even life-changing.

We know that simply having good managers is not enough to create this kind of environment in a restaurant.

Instead, we need strong and empowering leaders.

All of our managers are working to create this special feeling in their restaurant as part of their mission of becoming a restaurateur.

So it continues to be our top priority to do everything we can to help our field leadership and general managers create the kind of restaurant cultures necessary to become restaurateurs as quickly as possible.

While our financial results were challenged during the second quarter, the challenge arose from the cost side of the business.

Now, of course, we always have a lot of discipline in how we manage these costs.

At times, it's necessary to adjust pricing to cover inflationary pressures that can't be managed using our disciplined approach.

But I'm really pleased that our same-store sales and our new restaurant sales have performed so well, which is a tribute to our restaurant teams who continue to create the kind of experiences that our customers enjoy when they visit Chipotle.

I believe that as our people culture becomes even stronger through the development of more restaurateurs, we are going to be able to provide even better customer experiences, leading to more loyal customers, stronger sales trends, and better financial results.

I'm generally pleased with how our people culture has developed so far this year.

Since the first of the year, we've added 55 new restaurateurs, bringing the total number of these top-performing managers and future leaders to 239, when you include our apprentice team leaders, all of whom were restaurateurs.

As the restaurateurs continue to develop, so too does their impact on the business.

Today, nearly 60% of our restaurants are overseen by a restaurateur or a leader who has come through the restaurateur program.

But I know we can be more effective in developing even more restaurateurs faster than we are today.

And I also know that we can have an even more profound positive impact on how we hire and develop our future leaders, and how we serve our customers, if we can accelerate this development of restaurateurs.

One reason I think we can develop restaurateurs faster is that I'm more convinced than ever that the mere passage of time -- in other words, just having more experience as a General Manager -- has nothing to do with whether a manager is on right track to becoming a restaurateur.

A great example is our restaurateur Rob Anderson, who was just promoted a few months ago, and who leads our restaurant in Marlton, New Jersey.

Steve, Jack and I visited Rob's restaurant together for his restaurateur interview.

And on the way to the visit -- and none of us had ever been to the store before -- on the way to the visit, our paperwork illustrated for us that Rob had hired an entirely new crew and management team within just a couple of months preceding our visit.

Based on this, we were pretty pessimistic, to be honest, that Rob could have created the kind of special culture that we needed and that we wanted in such a short amount of time.

But Rob pulled it off.

His team was amazing.

Every single one of his crew is a top performer and all of them are confident, energetic, and empowered.

Rob was setting high standards and he knew -- and he and the crew were consistently meeting or exceeding those standards.

They were passionate about our vision to change the way people think about eating fast food, and they were focused on their own development and the development of their team.

And they had a real understanding of what they could accomplish at Chipotle, and what our culture was about, and what the restaurateur program is all about.

It was clear very quickly that Rob was a restaurateur.

And again, the mere passage of time had very little to do with it.

So Rob's story is part of a broader realization for us, as we're renewing a challenge we made at our all-manager conference last August.

At that time, we tasked all of our managers to become restaurateurs by the time of the all-manager conference.

To help accelerate the process of reaching this elite level quickly is going to require a new leadership strategy for our field teams.

Rather than focusing primarily on pushing their best managers sort of over the line to become restaurateurs or lifting up their lowest performers, they need to focus on making sure that every single one of their general managers is being giving all the leadership that they need to become a restaurateur.

Sure, top-performing managers like Rob will easily become restaurateurs because of the qualities that make them such high performers; and low performers are not likely to get there, even with a lot of help.

But our field management needs to be more -- it needs to be directing more of their focus to the general managers in the middle, who, with proper coaching and development, can become restaurateurs.

So I shared a new strategy that I believe will help our field leaders do this better, and it's been met with a lot of enthusiasm and excitement.

This coming September, we're going to bring our entire field management team together, and the entire agenda of that meeting is going to be focused on how to assess and coach our managers to become restaurateurs faster.

With this renewed focus by our field leadership, I'm optimistic that we can shorten the road to restaurateur for many of our really great managers.

As we visit our restaurants, we continue to find that we're not optimizing how we deploy labor throughout the day to ensure we've had -- that we have the right number of people during our peak sales hours.

We had hoped that our two new labor tools that you've heard us talk about -- the [Mini-Link] scheduling tool and our Prep and Deployment tool -- would allow us to deploy labor more effectively; but, so far, those tools have had only a limited impact.

We now have Mini-Link out at all of our restaurants, and the Prep and Deployment tool is in use in select patches in each region, and will be fully implemented soon -- probably during the third quarter.

Mini-Link is an online tool that allows our managers to save time on scheduling, which should enable them to devote more of their attention to developing people and improving operations.

It also provides better visibility, so our field leadership can identify poorly written schedules and fine-tune them to ensure we have the best coverage at peak times.

The Prep and Deployment tool is a tool that allows our managers to schedule specific tasks with standardized completion times, so that they can be more precise when scheduling individual prep assignments, for example.

We know that restaurants do the very best job with deploying labor throughout the day -- especially with peak hour coverage; as the restaurants that do that deliver superior throughput and better customer service.

But these tools are not yet consistently delivering on better deployment or better throughput.

The tools seem to be working well mechanically, and certain of our managers really use them well, but we're thinking we can improve on execution by simplifying and setting clear priorities around their use by our general managers and field management teams, which we're going to be focusing on in the coming months.

Ultimately, we continue to be optimistic that these tools will help our teams drive better throughput and strengthen our already-efficient labor model.

In terms of the United States Attorney's Office investigation -- at this time, there's really nothing new to report; no new developments beyond what we've already shared.

We have a solid and experienced team of experts in place, which allow us to give this matter the attention it warrants, but while allowing us to continue to focus the bulk of our time on our restaurants.

According to our attorneys, things are going smoothly, and we continue to fully cooperate with investigators, both at the United States Attorney's Office and at ICE.

We've already shared with you our use of the E-Verify System, the Department of Homeland Security's online tool, which allows us to verify the identity and work authorization status of every new employee immediately after the time of hire.

While we've been using E-Verify in all of our restaurants since March -- and we've hired approximately 12,000 new employees during that time.

I'm pleased to report that, according to the vast majority of our general managers, our people leads, and field management teams, it does not appear to be having an adverse impact on their ability to hire top performers for our restaurants.

Our managers have become familiar with the tool, and it's not presenting significant issues on the hiring front.

And we're still attracting a dedicated and diverse pool of applicants.

While I'm pleased with the quality of the candidates we are attracting, one of the current challenges we're facing is a recent increase in our crew turnover.

This increased turnover is likely due to a few factors.

Part of it seems to be related to the issues we had in Minnesota, Virginia, and Washington, D.C., which seems to have had a bit of a ripple affect around the country because of publicity surrounding the ongoing investigations by ICE and the United States Attorney's Office.

Turnover is also impacted by our field leaders' continued efforts to remove low and mediocre performers.

While turnover is higher than it's been over the last two years, it's still in line with rates we saw during 2007 and 2008.

So we're continuing to monitor the causes of this high turnover -- or higher turnover.

As you know, sometimes we applaud higher turnover if it's the result of our field leadership or general managers removing low performers.

But we know higher turnover generally can contribute to higher labor costs, due to the time required to train new employees who are generally not as efficient during their first weeks of employment.

For this reason, higher turnover can also impact our ability to deliver great throughput, extraordinary customer service, and our ability to manage the details of our business in the restaurant.

While we generally do a nice job in all three of these areas, we know we can do even better.

We're encouraged that turnover did begin to moderate in the last month or so.

Finally, I continue to be encouraged by the strength of our unit economic model, which appears to be stronger today than it has ever been.

The performance of our A modeling locations -- which continue to open at or near the volumes of our traditional locations -- has significantly exceeded our expectations.

Because the A models represent about 30% of our openings this year, these restaurants will continue to drive superior returns on our investment in new restaurants.

And our traditional restaurants continue to open at higher sales volumes as well.

I believe the continued improvement we're seeing in our new restaurants in particular, whether A model or traditional locations, points to the strength of our restaurateur culture.

With most new restaurants opening with managers or apprentices from restaurant to restaurants, we are opening new locations with stronger operations all the time.

And we're able to provide an exceptional and unique experience for our customers right from the beginning.

That is certainly a reason to be optimistic, as our pace of new openings accelerates for the remainder of this year.

The progress we're making to improve our unique food culture and the strength of our people culture gives me a continued sense of confidence that, in spite of some recent challenges, our business is extremely healthy, and we are well-positioned to provide strong returns for our shareholders in the future.

With that, I will turn the call over to Jack Hartung.

Thanks, Monty.

I would describe our second-quarter performance as a very strong quarter from a revenue and brand-building standpoint, but an extremely challenging quarter on the cost side.

We're pleased to report our fourth consecutive quarter of double-digit comps since the economy began to recover last year.

And our average sales volume for the nearly 1,000 restaurants that have been open for at least 12 months has passed $1.9 million for the first time, and now average $1,927,000.

And our restaurants are opening with the strongest sales ever, which combined, with the lower average investment fueled by the success of our A model openings, means our new restaurant economics are the best that they have ever been.

Now, normally, we would expect these results to translate into significant margin expansion and healthy EPS growth; but worse-than-expected food inflation, along with a number of charges during the quarter, have largely offset our strong revenue performance.

As I'll explain shortly, some of these costs are clearly one-time charges.

Some of them will recur for a few quarters, but we believe are not permanent.

And while food inflation is not temporary, we believe the price increase we recently began to implement will offset most, if not all, the inflation impact on our margins.

So while the second quarter net results were not as favorable as we would have liked, we believe our underlying restaurant economic potential for both new and existing restaurants is the strongest it has ever been.

Overall sales for the quarter increased 22.4% to $571.6 million, driven by new restaurant openings and a comp increase of 10%.

Year-to-date sales were $1.1 billion, an increase of 23.3%.

The quarter comp was primarily driven by increased traffic during the quarter; while higher menu prices, attributed mostly to [the Pacific] region, the increase we took in March, added 1.5% to the comp.

We opened 39 new restaurants in the quarter, including three relocations, bringing our year-to-date openings to 51 and total company-wide restaurants to 1,131 at the end of the second quarter.

We continue to expect to open between 135 and 145 restaurants for the full year.

Our new restaurants continue to open at very strong sales volumes, and are pushing toward the high end of our $1.4 million to $1.5 million opening sales range.

Restaurant level margin for the quarter were 25.8%, a decrease of 110 basis points compared to last year.

And year-to-date, our margins were 25.5%, a decrease of 100 basis points, as food inflation overshadowed the sales leverage we achieved in the rest of the P&L.

We expected food cost inflation for the year of around 5%, which, using the 31% food cost at the end of last year as a starting point, would have resulted in food costs of around 32.5%; but actual underlying inflation is currently running nearly 7% so far, causing our food costs to push close to 33% in the second quarter.

In fact, without the slight benefit of menu price increase in Pacific, our food costs will be slightly higher than 33%.

Of the sequential increase of 90 basis points for the first quarter, roughly half of the increase is due to the higher cost of avocados, while the remainder is due to inflation related to meat, primarily our beef.

For the balance of the year, we expect our food costs to increase further in the third quarter before the benefit of the menu price increase, by up to 50 basis points, as inflation continues with avocados, dairy and meats.

But we hope to see lower avocado costs in the fourth quarter, allowing our food costs to return to about the current level or perhaps slightly better before the menu price impact.

Avocados from California are in short supply and are premium-priced, that we hope to see relief, as we begin to source avocados from Mexico and Chile beginning in the fall.

As I'm sure you all know, we started to raise menu prices in select markets during the last half of June.

Other than our Pacific region, where we increased prices in March, we had not increased menu prices in nearly three years.

And as expected, when reviewing our menu prices compared to competitors in each market, we determined we have room to increase prices while remaining accessible or fairly priced to our customers, even though we believe our ingredients are far superior to our competitors.

With food inflation continuing, if not escalating, we felt it was time to invest some of the pricing power we've created over the years to help offset rising food costs.

The price increase started rolling out in the third week in June and is expected to be fully deployed in all markets during August.

Although the exact price increase varies by market, on average, the increase is about 4.5%.

Since the increase, when fully rolled, will impact about 80% of our restaurants, incrementally, the effective increase on the Company will be about 3.5%.

Keep in mind that Pacific menu price increases fully in the second quarter results.

Now, of course, included in the Pacific increase for March, the overall menu price run rate is about 4.5%.

Historically, we have always had solid pricing power, and believe that, even after this price increase, we continue to provide exceptional value for our customers based on our commitment to serving great tasting food, made with ingredients from more sustainable sources, and at a price that remains competitive.

Although it is still early, we're encouraged that we've not seen any evidence of customer resistance from either this recent price increase or the earlier one taken on the West Coast in the first quarter.

When fully rolled, the affected incremental increase of about 3.5% will benefit food costs by about 110 basis points.

We expect to realize around two-thirds of that benefit during the third quarter, assuming we stay on track and complete the rollout during August.

As a result of our strong transaction trends, combined with the impact of the price increase, we're increasing our comp guidance to an expected range of high single to low double-digit comps for the full year.

But achieving the high end of that range and finishing the year in double-digits can only be achieved if we experience little or no resistance to the price increase, and consumer confidence and spending habits hold up through the end of 2011.

Labor costs were 24.1% of sales, a decrease of 50 basis points from last year, as a result of favorable sales leverage.

Year-to-date labor costs are down 70 basis points from last year, at 24.3% of sales.

We continue to believe we can do a better job of deploying our teams throughout the day to be sure that we have the right staffing during our peak sales hours.

Labor also includes about 30 basis points of incremental Workers' Comp costs and we've seen a significant increase in claims in California.

We've invested additional resources in California to ensure that our work environment is safe and to aggressively fight any obvious frivolous Workers' Comp claims there.

While we expect our focus in this area to pay off over time, we expect our Workers' Comp costs to remain at about the same level for at least the next few quarters.

Occupancy costs for the quarter declined 50 basis points from last year due to favorable sales leverage.

Our other operating costs were down 40 basis points from last year, as marketing was 1.7% of sales in the quarter compared to about 2.1% last year.

Overall, we expect our marketing to remain around 1.7% for the full year.

G&A was higher than last year by 80 basis points.

G&A in the quarter includes about $1.3 million in incremental legal costs related to the US Attorney's Office investigation, largely due to document gathering to satisfy their information requests.

It also includes $1.3 million in additional employer payroll taxes related to employee stock option exercises, as well as $13 million in non-cash stock-based compensation expense, which is $5.9 million higher than last year.

As we communicated last quarter, non-cash stock-based compensation will be about $43 million for the full year 2011, an increase of about $21 million over 2010.

The significant increase in the non-cash charge is attributable to granting a similar number of options as in previous years, but at a much higher stock price.

Ironically, though our earnings year-to-date include a non-cash, non-economic stock comp charge of $22 million on a pretax basis, or about $0.42 to EPS, you'll see in our statement of cash flows that we have actually received an excess tax benefit, a real economic benefit of $29.7 million, which is not included in our earnings in any way; but if it were included, it would add about $0.93 to our EPS.

This discrepancy between accounting journal entries and cash flows helps explain our ability to fund our growth, buy back stock, and still add to our cash balance.

Our estimated annual tax rate was 38.2%, a slight increase of 0.1% from 2010, and that's due to higher estimated state tax rate, partially offset by one-time employment tax credits.

Diluted earnings per share for the quarter was $1.59, an increase of only 9% from last year, even though our sales increased by 22.4% in the quarter.

In addition to the impact on EPS of higher food inflation, higher Workers' Comp, legal fees related to the immigration investigation, higher non-cash stock-based compensation, and higher employee payroll tax associated with stock option exercises, we also recognized a loss in our investment in Soul Daddy, which resulted in a pretax charge of $2.4 million or an EPS impact of $0.05.

The three restaurants, which opened as a result of the TV show, America's Next Great Restaurant, were generating significant negative cash flows, and had run through all the funding provided by the investors, which included Chipotle.

Updating the status of our $100 million stock repurchase plan through today, we purchased over $53 million worth of our stock at an average price of $196.

Since we first started buying back stock less than three years ago, we purchased a total of over $253 million and an overall average share price of $87 per share.

We finished the second quarter with nearly $475 million in cash and cash equivalents, including short-term and long-term interest-bearing investments, and no debt on our balance sheet.

We continue to believe that the best use of our cash is to invest in our high returning restaurants, which we expect in the future will include growth in our international business, as well as our soon-to-be-opened ShopHouse Southeast Asian Kitchen.

In the meantime, we'll continue to opportunistically repurchase our stock to enhance the shareholder value.

Thanks for your time today.

At this time, we'd be happy to answer any questions you may have.

Operator, please open the lines.

(Operator Instructions).

Alvin Concepcion, Citi.

I just wanted to see if you could talk about same-store sales trends.

I know you raised your comp guidance because of the strong momentum you've been seeing.

So I just wanted to see if you could talk about what you've seen in July so far.

A similar trend to what we saw in the third quarter.

We did see our sales trends or transaction trends increase in the quarter.

If you looked at it on a two-year basis, we're up about 200 basis points -- basically at an inflection point where we increased our comp.

Roughly half of that is due to the menu price increase we took in Pacific.

Roughly the other half is due to an increase in transaction trends during the quarter.

And those same trends have continued so far in July.

So not a new increase in the trend, but a continuation of the trend that we started in the second quarter.

Okay, great.

And then I just wanted to clarify some of the comments you made around food costs.

I think you mentioned in the third quarter, you expect food costs to increase 50 basis points above the 33% level.

And if I understand that correctly, was that before price increases?

Yes, totally before price increases.

And our hope is that it will increase, but up to 50 basis points.

If we catch a break here, it might not be quite as high as the 50 basis points, but we think that that could be a possibility.

But then that's totally before the impact -- the benefit of the menu price increases.

So if you get two-thirds, it's 110 basis point benefit in the third quarter, it could be actually slightly under the 33% level in the third quarter (multiple speakers) --?

Yes.

That's right.

Okay.

And then, I guess, along those lines, if you could just summarize what you think the third quarter restaurant margin is going to look like versus the second quarter -- or even year-over-year, if you prefer to talk about it that way?

Well, we think -- some of these kind of one-time or some of these charges likely will cost some Workers' Comp costs.

We don't think they're permanent, but we do think that they will continue into the next quarter or two or so.

And so we can't predict when some of those will end.

But we think this menu price increase on an overall margin basis should allow us to -- once it's fully rolled in; so, in the third quarter, it's just partially rolled -- but once it's fully rolled in, which would be -- the fourth quarter would be the first time we'd get that full benefit, we think that we'll be able to get all of our margin back and maybe a little bit more, when you compare to what our margins were in the previous year.

As a perspective -- so we get about 110 basis points when it's fully rolled at the food cost line.

At the restaurant margin level line, we should get between 200 and 250 basis points of benefit from this price increase at the restaurant level margin.

Okay.

And then I guess you called out an increase in turnover lately.

How do you think labor costs are going to turn out as a percentage of sales going into the third quarter, relative to year-over-year or the second quarter?

Well, we don't know.

We think we've done an okay job with managing labor.

We've still been able to get leverage on this comp.

It worries us that we saw turnover increase recently, because we know it's a distraction when you have to hire new people and when you have to train new people.

Sometimes you hire new people that don't work out and you have to remove them after a short period of time.

And so we're concerned with that trend.

We're pleased that we've seen that trend moderate.

So, hopefully, it won't have a negative affect on labor, but if it doesn't continue to moderate, it could cause our labor to get a little bit worse.

But we're hopeful that we'll be able to do reasonably well in labor.

Okay, great.

Thank you very much.

Michael Kelter, Goldman Sachs.

I guess the first question -- I think your phrase you use when you talk about pricing was, there's no evidence of resistance.

I mean, does that imply an elasticity of zero that these are flowing straight through with no reduction in traffic to date?

Well, Michael, if that ends up being the case, if I can say that three months from now, then that would be -- that would be yes.

The answer would be yes.

It's early to tell on the increases we just took in June and in July so far.

So far, the signs are good.

We watched this on a daily and weekly basis.

The increase that we took back in March in the Pacific region, we haven't seen any noticeable evidence of resistance at all.

So, so far, so good.

But we have to be a little bit cautious because it is still a little bit early.

And then shifting gears, I know you guys have been playing with breakfast and what you might do there.

Can you maybe talk about what you perceive as the size of the opportunity?

And maybe what's holding you back at this stage and what it might look for you in the future?

Sure.

Well, we have breakfast in the Dulles Airport location.

And the reason we have it there is because it's required by our lease.

And it's going well and customers like it.

You know, we've been making some adjustments to the breakfast menu along the way, adjustments to recipes and cooking methods, and we're very happy with it.

You know, the Dulles Airport location, though, breakfast-wise is a little bit of an anomaly, because we're also serving most of our lunch and dinner menu there too.

So it's a little bit convoluted, if you look at it.

But overall, the sales are very strong at breakfast.

We think that there is an opportunity at some point to add breakfast.

How we might do that and when we might do that, we're not sure.

I can tell you, though, that the breakfast offerings, if we decide to test and then subsequently roll out a breakfast program, would be a lot more streamlined than you would see at the Dulles location.

And then the other thing which I was curious about was -- in Europe, obviously, very early in your expansion there, but you are looking to expand, clearly.

Can you maybe tell us what are restaurant sales for your London location and how they compare to US average unit volumes?

Because, I mean, we know that economics are employed there without scale; but what about consumer demand?

And how do the numbers look at the top line [a little better]?

Yes, Michael, we're not disclosing numbers.

With that -- what we focus more on is the quality of the team, the quality of the food, the reaction so far, all of which is very positive.

I can tell you, we said this in the past, that our London restaurant is doing higher volume than a typical new US restaurant.

And that's before adjusting for -- on a transaction level -- for adjusting for the currency difference.

If you adjust for the currency difference, it's much, much higher than our average restaurant here.

So they're off to a good start, but we're not ready to disclose what the specific sales of one restaurant are.

All right.

Thank you very much, guys.

John Glass, Morgan Stanley.

First, on labor productivity.

You seemed disappointed about the results for those two implemented programs you've put into place, and yet you did show some leverage during the quarter.

So, I guess, what were you expecting?

Or what do you think we should expect on a run rate basis when you get the benefit of those two programs, either in basis points or dollars?

Well, John, when I expressed disappointment, it's not because we're targeting a certain amount of labor leverage because of those tools.

That's just kind of not the way we look at it.

The way we look at them instead is, are these tools -- have these tools been able to deliver a sizable benefit to our customer experience by the way we deploy our labor -- have we gotten -- is our throughput a lot better, for instance?

Do we have all hands on deck facing the customers when the peak hours come?

Is all of our preparation being done before customers come into the restaurants?

Essentially, are people doing what they should be doing during the various times of day?

And are they doing it more efficiently?

And the answer is that we've gotten modestly better at some of those things, but we think that we have a long way to go.

And that those tools, by simply being rolled out, aren't going to do the work by themselves.

The tools are very good tools.

And if the manager works hard to understand them and get the lessons from them that they're offering, they can be very, very helpful.

But it takes time and a lot of -- a deep understanding in order to make -- in order to get the benefits from -- the operational benefits from those tools.

So, the reason I'm disappointed is because I'd hope that we'd be able to catch on a little bit quicker to get our deployment a little bit better, so that we would see an automatic increase in throughput.

Now, our throughput has gotten better.

It's gotten quite a lot better since the first quarter.

But then again, we're busier in the second quarter than the first quarter.

It's gotten -- our throughput is better than it was last year.

But considering that our sales volumes are so much higher, we think the throughput could be much, much better.

And that these tools are one great way for our managers and our field leadership teams to help us staff such that we can be in a great position to deliver great throughput.

So our comp sales are terrific.

We've reported comp sales we're very, very proud of.

But when we look where they're coming from, most of those comp sales are coming from -- not from lunch, not from dinner, peak hours, but instead from the rest of the day, the sort of shoulder hours, if you will, when the lines aren't as long at our restaurants.

And it's wonderful that our customers are so loyal that they're going to visit Chipotle no matter -- if there's a long line and they don't like that, then they'll come at another time of day -- that's great.

But we don't want to push our customers into that choice.

We want our customers to be able to come during 12.00 -- to 12.00 to 1.00 hour or the 6.00 to 7.00 or 7.00 to 8.00 hour for dinner, and be comfortable getting through the line quickly and not have it be a pain in the neck for them.

And that's something that we think we can do much, much better.

Okay.

So just to clarify, the lower leverage on labor this quarter versus last quarter had more to do with the higher turnover and the higher Workers' Comp expense, and not to do with that item?

Yes.

Okay.

And just two other quick questions relating to in, I guess, in the third quarter, you've got costs associated with the second store in Europe.

You've got your second concept opening.

You've also got that large field gathering.

Do those aggregate up to some one-time expenses we ought to be aware of in terms of pressure on G&A?

Not too large, John.

I mean, the conference that we're going to have in September is much, much smaller than the all-manager conference.

It's a matter of a couple hundred people rather than nearly 2,000 people.

So there's going to be a little cost there but not enough that I should single it out and give you a big number.

And then in terms of the openings, no, we don't expect any extraordinary costs during those times.

Okay.

And then lastly, on the legal expenses you incurred this quarter, will the third quarter be higher, same, lower, do you think?

We don't know yet what the legal expenses are going to be for the third quarter.

Like I said, the investigation seems to be going well.

We're told it's going very smoothly.

We have produced most of the documents that the government has requested from us, but there's still some left to produce.

At any time they may -- having looked through those documents, they may decide that they don't need to see any more documents or that they do need to see more documents, and we just can't be -- we're hesitant to predict that.

But, obviously, we're going to keep operating and keep producing whatever they need to see, in order to understand that we are a great corporate system.

Hey, John, just on your previous question, the answer is we're not expecting to add layers of G&A either for ShopHouse or for European as well.

I don't know if you caught that -- we're not adding any kind of layer of G&A for either of those.

Yes.

No, I'm thinking of that and startup costs or whatever else that you might incur (multiple speakers) --.

They're going to be there, John, but just not something that will be big enough to call out in the next quarter.

Okay, thanks very much.

Jeffrey Bernstein, Barclays Capital.

A couple of questions.

One I think from the -- as you look beyond the back half of '11 into '12, my guess is you don't have too much visibility.

But directionally, can you talk about, relative to the 7% food basket in '11, what you'd think in terms of inflation for 2012 as a basket?

And on a similar line of thought from a unit opening perspective, I know you're kind of on trajectory to do 140 this year with the 30% A sites.

I'm just wondering if you could talk about whether it's a potential that in 2012, based on what you're seeing from a site's perspective, you could accelerate that?

And how the A sites would fit into that accelerated unit opening in 12?

And then I had a follow-up question.

Yes, John -- or Jeff, on the food inflation, we don't really have visibility that I'd be confident about commenting on for 2012 at all.

As you know, as we all know, as we've been following this, it's been very fluid.

Our hope right now, based on what we see for the rest of this year, is that our inflation ought to level off.

A big part of the inflation from the last quarter to this quarter is avocados, which really isn't inflation; it's not -- it's more based on the growing season in California.

They had a light crop.

Their supply is down pretty dramatically.

And we think that's more cyclical.

And so that's why we expect that they'll get a little bit worse in the third quarter, and then level off.

And then I think we'll get back to about this same level by the end of the year -- maybe even a little bit better than this level, before considering the benefit of the price increase.

So we're hoping that we're going to see relatively stable inflation, not any kind of worsening inflation picture, once we get past the worst of the avocados for the rest of this year.

And then in terms of next year, we just don't know.

Hopefully, stable, but we'll know as we get closer.

And then, in terms of openings, it is too early for us to tell you what 2012 looks like.

That's something that we're still about halfway through our inventory building for next year.

The inventory building is going well so far, but we'll be in a better position in October with our third-quarter earnings release to talk about what 2012 might look like.

And then just on the margin perspective, obviously, there's the with and without the pricing.

But being that the third quarter is kind of a transition quarter, by the fourth quarter, you're expecting overall that you would see some more meaningful -- you could actually see meaningful restaurant margin expansion in the fourth quarter, if you don't get pushback on traffic.

Yes, that's right.

Okay.

And then just as a follow-on, would you expect that the A sites would increase as a percentage of the total?

And all else being equal, that you would accelerate the new openings if you could in '12?

Or is there any kind of reason why you would stay at that level, theoretically?

Yes, I mean, we look for great sites wherever we can find them.

And over the last two years, we have focused most of our work with the A model sites in proven markets, because that's where we wanted to essentially prove out the strategy.

This strategy has proven out.

It's, like I said in my comments, it's exceeded our expectations and we're having wonderful returns.

So there's no reason why we wouldn't continue to aggressively pursue as many A models as we can find in proven markets.

And we'll also be looking opportunistically now to look for A model sites in developing markets as well.

And so, over the next year or so, you'll see us layering in some of those and finding out how they do.

But I think you can understand that it is a permanent part of our strategy now, a very important part of our strategy.

And the numbers will be dictated more by what we find in terms of the sites we're able to locate out in our various markets than anything else.

So one example of what could contribute to the percentage going one way or the other would be the number of new developments that are coming out of the ground.

We're still looking at a situation where, whereas four years ago -- three, four years ago, we had 65%, 70% of our sites in new developments.

Now it's 65%, 70% of our sites are remodels.

So, again, there's not that -- because of the continuing weak economy, there's not that many new sites being built.

And so less of those new developments -- more of the new developments would probably be traditional models rather than A models in the proven markets.

So that's something that might affect it.

But we're still looking at that sort of 30% A models as where it's coming out now, and no reason to believe that that will shift dramatically in the short-term.

Okay.

And then just lastly on the clarification front, you talked a lot about the turnover.

Just wondering whether you gave any granularity or would, in terms of perhaps what the rate is now, and what the peak and trough, and perhaps impact of labor costs expectation over the next quarter or two?

Yes, I mean, our -- we usually talk about our crew turnover being sort of in that 100% range, which, for our industry, is pretty darn good with a lot of competitors being in that 160% range, that kind of thing.

So we've always been pleased that we are a lower turnover in a more full-time, more stable workforce than our competitors.

Right now, year-to-date, we're re running about 120% turnover.

So we are about 20% over where we normally are.

And while that's still terrific from the standpoint of what our competitors might be looking at, to us, it's quite a lot higher.

And while it's not the cause for enormous alarm, it's something that we look at and that we think we can do better, and something we'd like to see.

Like I said, it's been moderating recently, and so we're feeling like it's going to level off and get back to normal.

But it is something that has a cost associated with it so we want to keep an eye on that.

And one thing I'm always hesitant to talk about turnover as a bad thing, because keep in mind that we talk with our field leadership and our general managers very consistently about turnover isn't necessarily bad -- it depends on the restaurant.

In some restaurants that we walk into, we want to see turnover.

(laughter) In some of our restaurants that are running wonderfully, we don't want to see turnover.

So it just -- it really depends on how healthy that particular market is running.

So some types of turnover we encourage; some types we don't.

I think that some I would say involuntary turnover has resulted from the publicity surrounding all of the immigration stuff.

And that's had a bit of an effect nationally that we think has raised turnover up to that level that I mentioned.

Understood.

Thank you.

Sharon Zackfia, William Blair.

I actually want to follow-up on that question, because I think the turnover question may be the most important issue today.

As you look at the turnover and you're saying it's moderating, can you give us an idea of how it's moderating?

And I guess, what the true cost has been -- are you monitoring throughput in the stores where you're seeing the turnover?

I mean, are there sales being lost at this point?

I mean, have you seen a cycle like this in the past?

How long does it take normalize?

Okay, so, Sharon, I heard you ask about turnover and where it's moderating also.

I guess you were talking about its effect on throughput?

Yes, I think -- I mean, it seems like it has a lot of multiple impacts -- I mean, not only is there training costs but there's throughput.

I mean, at my local Chipotle, I think there are a couple of new people.

And you know when you're dealing with a new person, because they're slower.

Absolutely.

And there are people who get in the back of the line and then leave the back of the line because it's slower.

(multiple speakers) So I was just wondering if there are any metrics you can give us?

Yes, it's hard to give you specific metrics or formulas as to where things fall out; but just anecdotally, during April/May, turnover really went up quite a lot in those months.

And it seemed to be, like I said, associated with the publicity surrounding the United States Attorney's Office investigation.

No one seems to flee right away when we first announced that these investigations were taking place, but with the ongoing publicity, I think some people who perhaps had been approached for many, many times with other jobs, finally decided, well, I guess maybe I will move on to take another job, that kind of thing -- if they were concerned about their documents.

That's speculation, but it feels like there's a pretty tight association with that publicity and the sort of turnover we saw.

So how does that affect throughput?

I mean, certainly, there are situations where it doesn't; where you lose a person or two in a restaurant and we instantly replace them with top performers, and throughput stays the same or gets better.

But, generally, if you look at an extreme situation like Minnesota, where we lost a large number of people in a short period of time, throughput really crashed in Minnesota.

We really weren't as fast.

I think that, Sharon, you've experienced that in some restaurants, where, with a really new team, we just don't do as well with that kind of blocking and tackling in that particular aspect of customer service.

And so it does concern us when we have higher turnover, because it's going to affect throughput because there are fewer people with the experience of knowing exactly how to work that line really, really efficiently.

So -- but again, Sharon, we made throughput -- you know, I talked about throughput a year ago today, more or less, and talked about how we can do better.

And you know, we did.

Throughput got better.

I think what also happened, though, is our sales have gotten so much better, that when sales increase that much, sometimes we just don't keep pace with the sort of techniques that we're capable of in throughput to keep up with the greater sales.

We see that we are -- we see our capabilities in what some of our best stores do.

And we still have restaurants -- in fact, I just saw a record the other day, it came in from a restaurant that achieved a 350 transactions in one hour record.

That's her -- that's Sharon's restaurant.

Oh, yes, that's (multiple speakers) --

(multiple speakers) Sharon knows that one, so that's --

Yes.

So, well, if you're finding that one to be slow, Sharon, I don't have much for you.

(laughter)

It's the one by home, not the one by work, but I can give you the address.

Okay.

But anyway, Sharon, you know -- so we know what we're capable of.

We know what our top speed is, if you will.

And if you look at our throughput, it's gotten better, but it hasn't gotten particularly better in our 12.00 to 1.00 hour in our busiest restaurants.

There, our throughput hasn't gotten better.

And there, our comp hasn't gotten better during that hour.

And this is in restaurants, these high volume restaurants, where the overall comp of the restaurant has gone way up, but it's not coming from that 12.00 to 1.00 hour, which shows us that in that restaurant during that one hour, we've hit a bit of a roadblock.

And it's a roadblock that we needn't -- that isn't -- it's a roadblock that shouldn't be a roadblock.

And so that's what gives us -- I guess it's concern, but it's more excitement, knowing that we can really uncork that problem and get throughput rolling like it is in some of our high-volume restaurants, and really increase sales in some of our top-volume restaurants.

Okay.

And just one quick follow-up.

I guess, for a new Chipotle employee, I mean, how long are they typically employed before you would say they're kind of fully acclimated?

Is it like a 60 or 90-day ramp-up or --?

(multiple speakers)

Well, I'll tell you (multiple speakers) --

(multiple speakers) I know the longer they're there, the better they are, but --.

Well, Sharon, it depends.

It so much depends that I just can't answer the question.

I mean, literally, this guy Rob Anderson I mentioned, who is a restaurateur now in Marlton, New Jersey, which is near Philadelphia -- his average crew person had been there just over two months when we visited the restaurant.

And these people were absolutely remarkable -- I mean, phenomenal -- top, top, top performers.

These were people who I know that if you put them in a downtown Chicago restaurant and gave them proper training, in a week or two, these would be people who'd be able to really deliver great, great, great service and great throughput.

So if you get the right people, and if you hire carefully and if you train them well, we can get to impressive throughput numbers very, very quickly.

So it's just -- it's hard to say.

It's really hard to say it takes four weeks or six weeks or eight weeks.

Okay.

Great, thank you.

Nicole Regan, Piper Jaffray.

It's [Josh] on for Nicole.

I just wanted to talk about the philosophy behind the restaurateur program.

Is there a shift there, when we say that you all have figured out that it doesn't -- you don't necessarily have to be there for a certain amount of time before you can be a restaurateur.

Does that open up the opportunity for a high-performing manager to come from outside the Chipotle system into the system, and then kind of be fast-tracked onto a restaurateur program, where he might -- he or she might not have been able to do that in the past?

You know, I mean, certainly, that's something we've always -- we've never foreclosed that possibility.

I will tell you that the people who come from within our organization are the most successful managers.

And that remains true.

And our numbers of internal promotions are extraordinary now.

Of our salaried managers, our internal promotion rate is at 96%; of our hourly managers, it's at -- it's over 97%.

So literally, almost all of our managers are coming from within.

That being said, that leaves three or four out of 100 who we get from outside.

And we've always encouraged our field teams and general managers to always be on the lookout for top performers out there in the world, and hire them.

And you know, what we have found, though, is we have the wonderful ability to be able to attract very, very skilled people to come to our restaurants and be willing to take the risk, and often a pay cut, to start in a crew position, because we tell them, "Look, if you're really, really good, you can move up extraordinarily quickly at Chipotle."

So we don't tend to hire people from the outside too often, just because we've got this wonderful internal development program.

But when we do, they're often willing to start as crew members and work their way up.

We don't call it fast tracking, because we don't provide certain people a different opportunity than other people.

The ability -- the swiftness with which they move up through the ranks is determined by how good they are.

And so if someone comes in and says, "I am terrific; I've got a lot of experience; I will wow you," we can say, "Good, hop on in and let's watch it happen." And we've got our eye on you, and if you're good, we'll promote you very, very quickly.

But if someone comes from the inside and doesn't say that to us, and doesn't promise us the world but delivers great, great performance, they too will move up very, very quickly.

So we try to avoid terms like fast track, because a special -- that would imply a special program for people with a lot of experience and it's just not necessary, because our system accommodates both people from the outside and people from the inside very, very well.

Okay.

Great.

Thanks for that color.

And then just two quick follow-ups.

Is there a -- do you have a list of people that you might not have considered previously because, under the previous thought, maybe they needed to be there for a certain period of time?

Or, like you said, you hadn't really thought about it from this perspective?

Or is this now kind of a more organic process, where you're kind of maybe going back to the drawing board, and just really seeing who all is out there during all of your restaurant staff -- your trips to the restaurants?

Yes, I think more of a strategic shift based on what we're seeing.

What we see is what teaches us oftentimes.

And what we've seen is that certain people are able to do this very, very quickly.

And when I say do this, I mean development team of all high-performers, empower them to deliver high standards in our restaurants.

They can do it very, very quickly.

And we have been surprised at how -- the more we learn, the more we know that time is not the factor that helps someone get better.

What helps someone get better is doing the things they need to do to create a top-performing restaurant.

And that's empowering top performers to deliver high standards.

And so what we've done is we've realized that where, historically, our field leaders have spent a great deal of their time in the restaurants of the top performing people trying to bend the nail over, if you will, of getting those people to become restaurateurs -- we've discovered that a lot of that time they're spending perhaps isn't very necessary.

Those people are going to make it to restaurateur anyway.

Whereas if we can spread their time out and use more of it for a group of managers who no one was necessarily thinking would become a restaurateur in six or eight months, we've now seen why not assume that every one of their managers can be a restaurateur in six or eight months or a year.

And if they don't think someone can be a restaurateur within a year, well, then, what is it that makes them so sure that person can't be one within a year?

And if that's really the case, then we've got to have a discussion with that manager and find out whether we really think that they don't have that potential.

Because, again, just working at Chipotle as a manager, while a very valuable experience, isn't going to necessarily teach you how to build that very, very special culture.

Or it doesn't -- a period of time is not going to help as much as just doing things correctly.

And that does conclude the question-and-answer session.

I'll now turn the conference back over to you.

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

Thanks, everyone.

Thanks, everybody.

And that does conclude today's conference.

Thank you for your participation today.