Chipotle Mexican Grill, Inc. (CMG) Q1 2011 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Welcome to the Chipotle Mexican Grill First Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to introduce Chipotle's Director of Public Relations, Chris Arnold. Please go ahead, sir.

Hello, everyone, and welcome to our call today. By now, you should have access to our earnings announcement released this afternoon for the first quarter of 2011. 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 as defined in the securities law. These forward-looking statements will include projections of the number of restaurants we intend to open, restaurant development costs, comparable restaurant sales trend, food cost trends and effective tax rate, as well as statements regarding regulatory matters and other statements of our expectations and plans. These forward-looking statements are based on information available to us as of today, and we are not assuming any obligation to update them. Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We refer you to the risk factors in our annual report on Form 10-K as updated in our subsequent Form 10-Q for a discussion of these risks. I'd like to remind everyone that we have adopted a self-imposed quiet period, restricting communications with investors during that period. The quiet period begins on the first day of the last month of each fiscal quarter and continues until the next earnings conference call. For the second quarter, it will begin June 1 and continue through our second quarter release in July. 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 will now turn the call over to Steve.

Thanks, Chris. I'm very pleased to have started 2011 off with a strong quarter, and I remain confident that our performance is rooted in our long-term vision to change the way people think about and eat fast food. We're doing this by building a culture based on finding ingredients from better more sustainable sources, by preparing our food using classic cooking methods and by creating a compelling restaurant experience for our customers. We're also doing this by building a people culture based on recognizing, empowering and rewarding our top performers. This focused approach makes us unique in the restaurant industry, and continues to differentiate Chipotle in significant ways. Under the traditional fast food model, companies tend to look to drive down food costs, often by relying on cheap, heavily processed foods and by automating cooking to create industry-like efficiency. We've always chosen to go the other way, investing more money in the food we serve to get better ingredients from more sustainable sources and looking to improve the way we prepare our food. This commitment allows us to keep serving better tasting food all the time. It has been more than a decade since we first began to serve pork from pigs that were humanely raised outdoors or in deeply bedded pens and without the use of antibiotics. In that time, we have made considerable progress in our quest to serve food made with better ingredients from more sustainable sources. As you know, we continue to serve more nationally raised meat than any other restaurant company, an estimated 100 million pounds in 2011. And we're the only national restaurant company with significant commitment to using local and organically grown produce. And we continue to push ourselves to find better ingredients from sources that share our belief in raising food with respect for the animals, the environment and the farmers. As we move into 2011, we're expanding our use of cheese and sour cream made with milk from cows that are raised on open pastures rather than spending much of their time in confinement as most dairy cattle do. We're also sourcing more beans that are grown using conservation tillage methods, which reduces soil erosion, helping to preserve this critical non-renewable resource, and we will continue to increase our use of organically grown herbs. We call our commitment to better ingredients for more sustainable sources, Food With Integrity. But we are also very focused on the way we prepare these excellent raw ingredients. We have always used classic cooking techniques, techniques that enhance the flavor and help preserve the nutritional value of our great ingredients. And we are always looking for ways to improve in this area too. Right now, we're in the process of changing how we prepare the adobo we use to marinate our chicken and steak and to season our barbacoa and beans. Historically, we blanch the chili peppers in order to make our adobo. In reviewing that method, we found that it has a diluted effect and that we are losing some of the deep, delicious smoky flavor of Chipotle peppers. So we are working to eliminate this blanching step. Now we're using a special method of grinding the dried chiles, which produces an adobo with more complex, deeper characteristics smoky flavor that will improve the taste of our grilled meat, beans and barbacoa. And we're very pleased with this new method, and we'll begin testing it in selected restaurants soon. Similarly, we have changed the way we toast cumin seeds in order to capture the toasted flavor and added depth and balance to our food. Historically, our cumin would be batch toasted. Today, we are starting to toast and grind the cumin right before we use it in our various recipes, which allows us to capture more of the essential oils, making it more flavorful. And recent innovation in our use of new oil to fry our chips and taco shells. We've been using soybean oil for this, but are now testing a different oil, which has a number of benefits. It's a light tasting oil, high in mono unsaturated fat like avocados, making it more healthful and it’s a more stable oil that doesn't breakdown as quickly as soybean oil does, which will allow us to make chips and taco shells taste better more consistently. We're also changing our Roasted Chile-Corn Salsa by gradually switching from using yellow corn to sweet white corn, which we believe has a better taste and texture. We're improving kitchen equipment and design to make our kitchens more efficient. In our new restaurants, we're using a plancha instead of our grooved griddles. The flat grilling surface of the plancha not only allows us to make better tasting grilled meats like chicken and steak, but also allows us to cook different kinds of food, giving us that flexibility if we choose to use it. At one of our New York restaurants, for example, we have been testing a new chicken chorizo that we would not be able to cook on the grooved griddles that we have been using. The planchas are also more energy efficient and easier to clean. You'll see us gradually replacing the grooved griddles with planchas in our existing restaurants as well. We have also been remodeling kitchens in some of our older restaurants to make them more ergonomically friendly and energy efficient. All of these changes, whether to the ingredients, the cooking techniques, the equipment or the kitchen design help us continue to improve the quality and taste of the food we serve while providing our top-performing teams with a better work environment and the very best equipment possible. We're also continuing our efforts to communicate our commitment to serving Food With Integrity to our customers by aligning more of our marketing around this idea. In March, we began a new marketing program aimed at demonstrating our long-standing commitment to using high-quality ingredients. Through this program called Unlimited Time Only, we are wrapping burritos in gold foil rather than our traditional aluminum foil in order to attract our customer's attention to the quality of our ingredients. During the run of the campaign, we expect to reach some 35 million customers this way. The campaign plays off the limited time offers that are a cornerstone of traditional fast food marketing programs. By talking about our use of better ingredients for an unlimited time, we're demonstrating that ours is a commitment that never ends. We think that this is an important message, and one that people are increasingly ready to embrace In addition to wrapping burritos in gold foil, we have an ad campaign supporting the program that includes outdoor, radio and online ads. We have also produced a newspaper for our restaurant that speaks to our food philosophy, highlights some of our farm partners and discusses some of the important issues in our food system. And just this month, we launched an online contest called Wrap What You Love where our customers can wrap things that matter most to them in gold foil and upload photographs of those things on our website for a chance to win prizes, including $10,000 in cash or one of five custom minted 24-karat gold Chipotle coins. The online campaign also raises money for the nonprofit FamilyFarmed.org in support of their programs to help family farmers bring more local food to market. We're continuing to make progress on the development of our Asian concept also. The Asian restaurant called ShopHouse Southeast Asian Kitchen is inspired by traditional ShopHouses found throughout Thailand, Malaysia and Vietnam. Traditionally, ShopHouses are two, three story buildings where families live upstairs and operate restaurants or fresh markets on the ground floor. The ShopHouse menu will draw on a bold and complex flavor of Southeast Asia and we'll use sustainably raised ingredients, grilled and braised meats, an abundance of fresh vegetables, herbs, spicy sauces and an array of garnishes. For anyone who has traveled to Southeast Asia, you've seen that food can be served fast and it's also flavorful, nutritious and affordable, which makes it something that we think that’s well into the Chipotle service format. ShopHouse will open this summer in Washington, D.C. While we believe ShopHouse gives us a great opportunity to see how our model will work with other types of food, I’ll remind you that our focus for the foreseeable future will remain on Chipotle. Our first restaurant in Paris is also slated to open this summer. The restaurant will be led by Damon Biggins, one of our Restaurateurs who work with Jacob Sumner, our London Restaurateur, to open our restaurant there. Our initial plans for Paris are very much the same as London. We plan to get this first restaurant open, introduce the Chipotle brand, develop relationships with like-minded suppliers and begin to develop a team of high performers so that any growth in that market can follow the same path that has worked so well for us here in the United States. Our continued focus on things that have the greatest impact on our business continues to keep us moving in the right direction. And I remain confident that we are positioned to provide value for our shareholders going forward. I'll now turn the call over to Monty.

Thank you, Steve. We're pleased that 2011 started with such a strong quarter and that we continue to produce great results for our shareholders, while maintaining our focus on the things that really drive our business. Beyond the continued improvements with our food culture and our commitment to serving Food With Integrity, that also includes continued emphasis on improving our culture of top-performing employees who are being developed into our future leaders. Our Restaurateur has continued to lead the evolution of this special culture. As you recall, they are our most elite managers who have demonstrated a talent for building strong teams by empowering top-performing crew to deliver Chipotle's high standards. Their restaurants continue to set the standard for excellent operations, great food and motivated and upbeat teams, all leading to an exciting customer experience. Since our last call, we reached an important milestone with our Restaurateur program when we named our 200 Restaurateur earlier this month. This growing group of top performers, many of whom have worked their way up from hourly crew positions, continue to provide more and more future leaders for our company. As they continue to empower their teams, they are making better careers and better lives for themselves, as well as for all those with whom they work. It's how Chipotle's enabling people to take part in the American dream in a totally unique way. We witness the truth of this statement by the reaction we see nearly every time we name a new Restaurateur. In fact, we believe that our future officers and executives will come from among this group of extraordinary managers, which means that crew positions at Chipotle come with a remarkably exciting opportunity for advancement. As of now, more than half of our Restaurateurs -- excuse me, over half of our restaurants are overseen by Restaurateurs or someone who has come up to the Restaurateur program. So what we have said for some time that it was our goal to develop our future leaders from within, that goal has now become a reality. Of course it doesn't stop with our Restaurateurs. Increasingly, we have people who started working with Chipotle’s crew who are ascending into regional or national leadership positions. For example, each one of our 15 apprentice team leaders are Restaurateurs who have demonstrated their ability to build exceptional restaurant cultures outside of their own restaurant. Each of these leaders has developed at least one additional Restaurateur and now is responsible for eight restaurants. And now we're seeing these apprentice team leaders start to become team leaders who have even broader responsibility. One example of this is our newly appointed team leader, Pedro Ochapa [ph], who joined Chipotle six years ago from another retail job, but had no restaurant experience. All he had was a deep love for our food and our culture, and a belief that through hard work, he could become a leader here at Chipotle. From the beginning, he demonstrated natural leadership skills and the willingness to work hard. He worked his way from crew to General Manager and then ultimately, to Restaurateur. Almost immediately after becoming a Restaurateur, he took on a second restaurant where he helped the GM of that restaurant become a Restaurateur within only a few months. He then started working with another restaurant and another and last September, the managers of each of these four restaurants all become Restaurateurs. At that time, he was promoted to apprentice team leader. He was the first to achieve the remarkable feat of assisting every single one of his four restaurant managers to become Restaurateurs, but we're certainly looking forward to seeing that happen many more times in the future. After becoming an apprentice team leader, Pedro soon developed more Restaurateurs and recently became a team leader. Beyond the incredible work of our Restaurateurs and field leadership teams, we are also working to develop tools to help our teams to provide even better customer service and to become even more efficient. We have deployed a new scheduling tool, which is easy to use and will help our managers deploy their labor hours to deliver the best customer experience possible. While our managers have always done a good job with scheduling, the right overall hours for each day, this tool help them better allocate labor during each hour of the day based on expected hourly sales. Because it's a web-based tool that allows our field leadership to view the schedules remotely and to better coach their teams on how to write a great schedule. Our goal for this tool is less about saving labor hours and a lot more about ensuring that the hours we do spend are going to lead to the best customer experience possible. Similarly, we continue to test the prep and deployment tool, which allows our managers to assign each of the daily prep tasks, such as making salsa or guacamole, cooking chips, marinating chicken and steak, chopping cilantro or cutting feet of vegetables, for example, it allows them to calculate accurate completion times for these tasks for each person. So this tool, alongside our web-based scheduling tool, is going to allow us to staff the right people in the right positions based on sales volume, which will result in a better customer experience and even better organized shifts. So while managers have always tracked this data manually, this tool helps them to fine tune their management skills and also help them -- helps sort of the learning curve for new managers. Overall, it's going to help all of our restaurants not just those with experienced managers, better manage crew tasks so that we can have our prep completed and all hands on deck serving customers during our peak hours. All of our reasons are testing these tools and select patches, and we plan to have it rolled out nationwide later this year. Finally, I would like to update you on the immigration issue we've been working through. We're continuing to work with immigration and customs enforcement to make sure that we're doing the best job we can to properly carry out our responsibilities. And now, we're also working with the office of the U.S. Attorney for Washington, D.C., Criminal Division, which has asked us to provide them with certain documents as part of a review that they're conducting. We are relatively new to this process and they're not fully aware of the specific details about how these agencies do their work. But we are told that it is customary for ICE and the Assistant U.S. Attorney to work together so it makes sense that they will be interested in reviewing this incident to be sure that our handling of the issue has been appropriate. We've been completely open and transparent with both ICE and the U.S. Attorney's office, and our discussions with them seem to be going well. As we mentioned during the last call, we have learned a lot from these experiences. We've always had comprehensive policies and procedures in place to help ensure that every individual we hire is legally eligible to work in this country. But the situation in Minnesota showed us that we remain vulnerable. So we have outlined a detailed plan to improve our procedures for employee verification and documentation, and we have submitted that plan to ICE. We believe our plan addresses all of their concerns. We're now working to roll out these enhancements. In mid-February, we voluntarily began a nationwide rollout of the Department of Homeland Security's E-Verify system, which uses government databases to verify the work eligibility of each employee at the time that they're hired. This nationwide rollout was completed at the end of March and we are now using this tool nationwide for all new hires. Of course, we've been using E-Verify for some time in the states where it's required, which are Arizona, Utah and South Carolina, but we're now using the tool in all of our U.S. locations. Through the first weeks of the E-Verify use nationwide, we've been pleased to find that we're still attracting top-performing applicants who will help us to preserve our valuable and unique people culture. In the coming months, we will be implementing other improvements as well, including the use of electronic I-9 forms, which will help us to mitigate errors and should streamline managers immigration compliance responsibilities. We're also hiring a dedicated I-9 specialist, who will work at our Denver headquarters and will take over responsibility for the second level of I-9 screening. Ultimately, all of this is part of our overall strategy of setting our employees up for a long and fruitful career as the future leaders of Chipotle. Chipotle's success is driven by our focus on doing just a few things, primarily the development of our unique food and people cultures, and we believe the steps we're taking to improve our employee verification policies will reduce the likelihood of incurring the kind of distraction we saw in Minnesota and will help keep us focused on the things that really drive our business. I will now turn the call over to Jack.

Thanks, Monty. We're very pleased with the results of the first quarter as our restaurant teams had the chance to serve more new and existing customers than ever before. Our empowered top-performing crew managers were busy delighting our customers by serving great tasting food made from premium ingredients, which has allowed our strong customer transaction momentum continue into the first quarter. While our margins and financial result for the quarter were affected by higher food costs, which we have not yet passed along to our customers, we view this margin challenge as largely temporary and manageable over time. And we're confident that our strong unit economics with average restaurant volumes now at $1,885,000 can get even stronger as more customers choose to visit Chipotle. Sales for the quarter increased 24.3% to $509.4 million, driven by new restaurant openings and a comp increase of 12.4%. The comp was primarily driven by increased traffic during the quarter, while higher menu prices added 0.7%. During the quarter we conducted an online promotion in connection with the America's Next Great Restaurant television show where customers who view the video promo for this show could visit Chipotle and buy a burrito and get one free. This was the first national promotion we've ever done like this and the participation was far greater than we anticipated with over 1 million customers visiting our restaurants to redeem the BOGO offer. The promotion ran for only about two weeks and the redemption was so high we believe the promotion added nearly 1% to the comp overall for the quarter. While our comp trends return to pre-promotional comp trends after the offer expired, we were delighted to offer the chance for new customers to try Chipotle and for existing customers to visit more often. And we faced progressively tougher comp comparison this quarter as the year unfold. The momentum we have seen so far has led us to raise our comp guidance from low-single digits to mid-single digit for the full year. Most of the 0.7% effective menu price increase I mentioned earlier comes from the increase we took in a few markets in the second quarter of last year. About 20 basis points relates to menu price increases taken last month in our Pacific region. Though our Pacific region, including California, has much higher cost of doing business than our average markets, our menu prices there have lagged the rest of the country. After the increase of about 4.5%, a burrito in the Pacific now costs about the same as the rest of the country, which means we're still not fully recovering the higher cost of doing business there. The increase has only been in place for several weeks now, so it's too early to fully evaluate customer resistance, but so far we're not seeking any. Although we increased prices in our Pacific region, we plan to hold off on price increases for the rest of the country until the third quarter, which will allow us to see the magnitude and timing of inflation and to assess the customer reaction to price increases at other restaurants, as well as from our customers in California. We continue to believe we have pricing power, but we want to be patient and allow our transaction to hold as strong as possible in this still recovering economy. Diluted earnings per share for the quarter was $1.46, an increase of 22.7% from last year. EPS grew at nearly the same rate of sales despite the much higher food cost in the quarter as leverage in labor, occupancy and depreciation resulted in our operating income margin of 14.7%, being down only 30 basis points from last year. EPS in the quarter benefited by $0.02 as a result of a non-recurring catch-up adjustment for state unemployment tax refunds related to previous years. Restaurant-level margins decreased 90 basis points in the quarter, and higher food, promo and marketing costs were offset by leverage in labor and leverage in occupancy. Food costs were 32%, which is up 180 basis points from the first quarter of 2010 and up 100 basis points in the fourth quarter of 2010. Of the sequential increase of 100 basis points from the fourth quarter, about 60 basis points relates to a higher tomato and produce costs due to the freeze in Mexico and Florida. Although there were severe crop loss and quality challenges with our produce, we were able to remain fully supplied throughout all of our markets. In addition to the 60 basis point impact on food cost from the freeze, the remaining 40 basis points of higher food cost in the quarter relates largely to expected inflation in ingredients such as beef, chicken and avocados. While the worst of the impact from the freeze is behind us, we're just now seeing a return to normal tomato prices. And therefore, the second quarter will still be impacted by about 20 basis points, an improvement of about 40 basis points from Q1 related to the freeze. But this 40 basis point relief from the effects of the freeze and food costs will be more than offset in the second quarter by general commodity inflation and higher-than-expected avocado cost due to lower-than-expected avocado harvest especially in California. We expect the most significant pressure in avocados throughout the summer, and higher avocado prices will add about 50 to 60 basis points to our food cost during this time. Labor cost decreased 80 basis points to 24.6% in the quarter. The decrease for the quarter was a result of labor leverage, driven by the comp increase, along with a 20 basis point benefit from the non-recurring state unemployment tax refund. Labor cost continues to include about 20 to 30 basis points from additional crew training in Minnesota, along with increased staffing for actual and potential turnover in DC and Virginia related to the ICE investigation that Monty talked about. Other operating costs increase 60 basis points to 11.3% for the quarter. The increase was due to increased promotional expenses from the BOGO offer, along with higher marketing expenses during the quarter. Marketing was about 1.3% of revenue this year compared to 1.1% in Q1 of last year. We anticipate our overall marketing for the full year will be around 1.7% of revenue, but we will significantly increase our marketing efforts in the second quarter. Marketing in the second quarter will be about 2.2% of revenue as we invest about half of our annual media budget supporting the efforts Steve talked about. As a result of continued inflation, inefficiencies in labor in Minnesota, DC and Virginia, the timing of our marketing expense and our decision to remain patient before passing along the higher costs of food inflation to our customers, our restaurant margins will continue to be under pressure in the short term. But we are confident that our food culture, our people culture and our business model are as strong as they've ever been, and that these margin pressures are cyclical and manageable within our model. G&A was down 10 basis points to 6.3% of revenue. The decrease was driven by leverage from higher average restaurant sales. The leverage resulting from increased comp growth was mostly offset by the impact of higher, non-cash stock-based compensation, which was more than $9 million in the quarter, compared to under $5 million in the first quarter of last year. Stock-based compensation will be about $43 million for the full year of 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. We expect to open 135 to 145 restaurants in 2011, including our first restaurant in Paris during the second half of the year. Openings will be heavily weighted to the second half of the year. Our new restaurants have historically opened between $1.350 and $1.4 million, but have trended consistently above that range for the past year or so. So we now expect our new restaurant openings to open in the $1.4 million to $1.5 million range, which further strengthens the expectations for our restaurant economic model. Our estimated annual effective tax rate and the tax rate for the first quarter is 38.25%. For 2011, annual effective tax rate reflect an increase of about 20 basis points compared to 2010 due to lower expected benefit from our food donation program. Just a quick update on the status of our current $100 million stock repurchase plan. Through today, we purchased over $45 million worth of stock at an average price of $185. While we believe that the best thing in high-returning restaurant remains the best use of our cash, we'll continue to opportunistically repurchase our stock to enhance shareholder value. Thanks for your time today. At this time, we'd be happy to answer any questions you may have. Operator, please open the lines.

[Operator Instructions] We'll take our first question from David Tarantino, Robert W. Baird. David Tarantino - Robert W. Baird & Co. Incorporated: A question on your recent comps momentum. Jack, I think you mentioned that confidence and the recent comps you've seen have increased your confidence in the full year and you're raising it to mid-single digits. But could you tell us or maybe give us an idea of what you've seen so far in Q2? Has the trend in Q1 carried over into Q2 for example?

Yes, David. We felt good about -- it was a choppy quarter. I think we mentioned that during our first quarter call because of weather early on. But once the weather kind of cleared, we felt really good and still feel good about the transaction trends during that first quarter. And so the two things I would keep in mind as we look ahead to the rest of the year is one, we got the tougher comparisons. So as we move from the first quarter to the second quarter, we did see an expected reduction in our comp percentage despite going up against the tougher comparisons. And the other thing I would say about the 12.4% comp in that first quarter, 1% of it did come from the BOGO, and I would expect that to be nonrecurring because we did see a steep spike in our transactions during that promotion and then we did see the transaction level return to pre-promotion levels. So I would strip off 1% and then other than the tougher comparisons through the rest of the year, we feel pretty good about holding on to a nice transaction momentum. David Tarantino - Robert W. Baird & Co. Incorporated: Okay. And just a clarification as you -- you said as you've entered the second quarter, you've seen the comps ticked down against the tougher comparisons? Are you still sort of running in that double-digit range, or maybe a...

No. What I would mean, David, the first quarter we're going up against the 4%, the second quarter we're going up against, I think it was an 8.7%. And so we saw an underlying reduction in the comp percentage, call at that 4.5% or so. Call it running in that kind of high single-digit range.

Next up, we'll hear from Joe Buckley, Bank of America Merrill Lynch.

Thank you. Two questions. You mentioned adopting E-Verify and change from your documentation process for new workers, does that also apply to existing workers and our turnover rate's going up as a result of these changes?

Thanks, Joe. The E-Verify system is designed and meant to be used upon hiring new workers and in fact it's not permissible to use the system on the existing work population. And so, yes, it's just a prospective tool. With regard to turnover, we have not seen turnover increase as a result of implementing E-Verify at this time at all.

Okay. And then curious on very first A Model stores that you opened last year and, I guess, maybe any opening in this first quarter. Kind of on two fronts. How they are tracking versus the higher new unit volumes in general, and as you wrap the openings of the very first one, I think ramping up in sales as a more traditional sized store or more traditional store would?

Yes, in terms of how they're tracking, we're really pleased with the A Models because they are still keeping pace, they opened at not quite the volume but very near the volume of our traditional, I should say, regular restaurant openings and that has remained true up to today. And with regard to those that are lapping or going comp, I mean the ramping of these restaurants isn't any different than any of the other Chipotle restaurants. So they're behaving in just the same way.

Our next question today comes from John Glass, Morgan Stanley.

Thanks. First, just on the BOGO promotion, did you quantify what the margin impact was in that other operating line? And if not, could you? And more broadly, does this cause you to think -- rethink about how you might promote? Is this something you might try again or did you feel like the margin cost was too great? I mean is this something you might expect later in the year again?

Our promo, John, for the quarter was up about 40 basis points. And we're not sure if we would do it exactly this way again. We know we like the response. Frankly, we weren't as ready as we should have been because it far exceeded our expectations and so our restaurants scrambled, our purchasing team scrambled. So for one, we'd want to be better prepared if we did a national promotion. We also think that we're probably connected with a lot of our existing customers and so our existing customers probably had a chance to come when they were going to come anyway. We're not sure did they come an extra visit or did they just replace the visit one week with the next visit. So I think we might try to attract a slightly different audience. So we're interested in doing something like it, John, but there's definitely things that we learned that we might do differently. And certainly, probably most importantly, we like to invite customers to come in and then we like to hold onto it. We like to not see -- we don't want to become a restaurant company that has spikes in volumes based on some kind of an offer or deal, and then see the sales return to previous sales levels. We'd like to have a bunch of people come in and then have the sales level be at a higher level than before the offer started. So I think we'll be interested in doing similar type promotions, but we think we'll be able to improve it.

And then just if you could, could you just summarize your comments about what you think second quarter restaurant margin will look like, maybe relative to the first quarter a year ago? Is it going to be worse pressure when you sum all the things together, you just talked about the last pressure? Can you maybe just help define what you mean by…

Yes, I think it will be a little bit worse, John, in the second quarter. And the reason is food cost is going to be higher in the second quarter, we believe, than the first quarter. So with food cost in the first quarter of 32%, we do get a break on the freeze because we'll pick up 40 basis points. But avocados are going to be more expensive than we thought. There's just not as many avocados coming out of California as we hope so. We think avocados are going to be up about 50, 60 basis points more than we had originally thought. So that more than wipes out the benefit from the freeze. And then we've got kind of normal underlying inflation. We still think that underlying inflation, not counting the freeze, not counting avocados, which we consider to be more cyclical based on nature's harvest, we still think that's going to be in the mid-single digits. So we think that second quarter food costs will probably be more in the 32.5-ish kind of range. Now our hope going to the third quarter is that avocados will begin to improve, we'll pick up the 20 basis points remaining from the freeze and then hopefully we'll be at a similar kind of food costs in the third quarter before considering any kind of price increase.

Okay, and then other pieces of restaurant margin besides food costs that are better or worse sequentially or year-over-year?

Yes, I mean we're losing 20 basis points of nonrecurring in labor and other than that, advertising will be close. We spent about 2.1% in the second quarter of last year. We'll be about 2.2% this year, so that's pretty close. We expect promo to be back to normal. So most of the rest of the P&L, John, should be roughly in line, if that helps.

Next up, we'll hear from Nicole Miller Regan, Piper Jaffray.

Thanks. This is Josh for Nicole. I want to see if you guys could provide an update on the loyalty program even -- I'm working on and see if, and also share any learning from that?

Sure, well, we expect at this quarter, we will initiate the loyalty program. And remember, initiating the loyalty program is having our restaurant managers and crew reach out and present an invite to our very best customers. We're hoping to invite about 100,000 customers initially into this program. So that has not started, but we anticipate that starting in this quarter. And again, the idea behind this is inviting our very best customers to gain access to a part of our website that is an invite only to become involved in this interactive environment where they learn more about what makes Chipotle special. They will be rewarded through clothing items and free food and things like this by sharing what makes Chipotle special with their friends and family and coworkers. And we think that building this kind of loyalty is really the best way to do it. It's much more -- we think we're building a stronger relationship than a typical buy 10 get one free kind of loyalty. So expect to see that coming out this quarter.

We'll now hear from Michael Kelter, Goldman Sachs.

I wanted to ask about comp trends and follow up on one of the questions earlier. I guess, I'm wondering you guys are stepping up the marketing spend with the gold wrapper program and some of the others. And yet you're saying that comp trends are in line with what they were before. So is there any way you're measuring the effectiveness of the incremental advertising and feel comfortable that it is driving a step change?

Yes, it's a good question, Michael, and we certainly want to advertise and connect with our customers in any special way. We've done in the last year or so and we'll continue to do a lot more research than we've ever done historically. And so what we're finding is although some of our advertising, it’s not necessarily designed to drive customers into our restaurants right away. It's not a $0.99 this or it's not something that's intended to drive, I mean the BOGO was. And so we'll do things from time to time like that. But this advertising is more designed to peak our customer's curiosity about food integrity and our ingredients. And things like the gold foil, which is part of our marketing effort. It actually cost more to wrap our burritos in gold than it does in aluminum. It's designed to peak their interest and ask a question about why the gold foil, which gives our crew a chance to explain about food integrity and what naturally raised meats and organics and things like that. Same with the billboards, the radio spots, everything else that are really designed to in a non-preachy way, peak the curiosity about food integrity. It's not necessarily going to translate into instant sales in our restaurants. But the research, Michael, is designed to tell us and so far, we've been pleased with our advertising last year, and haven't seen early research yet on advertising this year. We hope that it will continue to tell us that people are becoming more curious about the things like food integrity, the things that Chipotle now is becoming known for, that they do associate Chipotle with things like naturally raised and organics and better ingredients. And that they're more likely to visit Chipotle or other restaurants that offer these types of ingredients. And so the research that we've seen so far with our previous ad campaigns has been very encouraging. And we'll do the same types of things. We know that if customers feel better about the food at Chipotle that it will result in transactions even if it's not immediate.

And then on a different topic on the labor issue, can you may be lay out for us what the potential outcomes might be of a criminal investigation and even if you don't have an idea of which one it might be, what are the potential outcomes?

Well, it's very early in the process, and we're not sure even exactly what the agencies are looking for in particular. But obviously, like we’ve told you in the past, we've worked very hard in the past to be sure that our hiring practices and procedures have met or exceeded our legal obligations at all times. And they were confident that any investigation will reveal that that's the case. That being said, we at Chipotle are always trying to learn whatever we can from any situation that confronts us. And certainly, the situation in Minnesota had us wanting to find a better answer. And that better answer had us going back to look at our hiring procedures and practices, and we believe that we've done a fair amount to enhance them to make them even better in the future. And one key aspect of that is our decision to use the E-Verify tool to dramatically increase the likelihood that those who we hire to join our team will have a long and fruitful career with Chipotle. So we do not expect this to be a disruption to our business. We're confident that at the end of the day, the conclusion will be a good one for Chipotle. And in the meantime, we want to make sure that our -- we want to focus on our hiring practices to make sure that they support a really strong Chipotle people culture, which is at the heart of what drives the special experience in our restaurants.

And if it doesn't turn out in your favor? I guess, I'm just trying to understand, is it simply a financial impact? Are there any broader implications? What if the unlikely does happen?

Yes, like I said, we're very confident. I mean, at Chipotle, we work very hard to do the right thing. We do the right thing with the food we select, we do the right thing with how we treat our people and we certainly do the right thing in complying with the law. So for this reason, we're being tremendously open and transparent. We're working with the governmental agencies. We want to give them whatever it is that they'd like to look at. We're not concerned that they're performing an investigation. We understand from the folks we've talked to that it's very customary that when you have a lot of media attention as we did have with regard to the Minnesota situation, plus the fact that we lost 450 people in Minnesota, that it would be customary that the government would want to get involved and make sure that everything is on the up and up and that Chipotle is managing this situation responsibly. So we really are very confident that ultimately the outcome of this will be a good one.

RBC's Larry Miller has the next question.

Yes, thanks very much. Hey, Jack, can you give us a sense of what rate of pricing you're contemplating in Q3?

Larry, we don't know right now. In fact, we're in the process right now of gathering competitor pricing. We believe we've got pricing power. In fact Michael, who's just on the call, did an independent study where he surveyed 30 restaurants and on a bunch of different matters and one of the things was on pricing power and we scored at the very top of the list of the 30 and so. That makes us feel good that what we sense in our markets that we've got pricing power, but what we want to do is go market by market, gather what competitor high pricing will be and then we'll make a decision probably in the second quarter and then be prepared to increase prices in the third quarter. I think, Larry, in terms of what an objective might be, one objective I think you can reasonably expect that our margins in the second half of the year will be at least equal to what they were last year. I think it'd be kind of silly of us to look at the price increase to cover inflation, and then not at least hold our margins at the level that they were in the second half of the year in 2010.

And by that you mean restaurant-level margins, correct?

Restaurant-level margins, yes.

Okay. Good, so that's really helpful. Can I also follow up on the immigration issue? You said you haven't seen any increased turnover. Is it your sense that ICE is going to make you document all the workers in your workforce? And if just so, can you give us a sense of what the Hispanic population of the workforce is currently?

Well, let me just be clear that ICE has current work with us, notwithstanding. We have always documented all of our workers in our workforce as is required by the law. So we've always asked them for the appropriate documents, we've always inspected those documents, we've always filled out an I-9 form as required by law. So there really is no change there. What we're doing to bolster our procedures are some of the things I named like using the E-Verify tool and the paperless I-9 system, things that will help our managers be certain to complete the I-9 form correctly and accurately, which will give us more confidence that we're doing the right thing. In terms of the kind of workforce we have, at Chipotle, we look very, very hard to get the right people to work for us. And by the right people, what we mean is we look for entry-level crew people that have what we call the 13 characteristics, which are certain characteristics that you cannot train, but that we believe are important indicators as to whether somebody can be a superstar at Chipotle. So we look for people with those characteristics and we hire them. And we hire them with no regard to race or gender or anything like that. So we have a very diverse workforce. With regard -- since the implementation of E-Verify, I can tell you that we've already hired well over 1,000 people with that system in place, and we're pleased to tell you that the demographic of the people we hire has not changed materially. We're still hiring a very diverse workforce and we're hearing reports that people are very pleased with the fact that the system has not deprived them of hiring plenty of top-performing future leaders at Chipotle.

Next we'll hear from Sharon Zackfia, William Blair. Sharon Zackfia - William Blair & Company L.L.C.: I was curious as you're gearing up to open the first ShopHouse this summer, what are the parameters that you're looking to decide whether or not to open more and kind of how quickly would you expect to make decisions and rollout especially the concept?

Sure. I mean I've been really, really disciplined to just think about opening one restaurant and making sure that it's really, really good. Not only that customers love the food and love the experience, but also that it really follows the Chipotle model, especially the economic model. I mean the engine behind Chipotle that makes it special is the economic engine that allows us to pay for food with integrity type ingredients and to invest in our top performers to become future leaders of the organization. And because of those two things, because the economic engine drives that, I think it gives us an advantage over other concepts, other fast food places and other restaurant concepts. That's going to be key in driving ShopHouse. The menu is great. I think people are going to love it. Yes, you're going to have -- customers will have choice just like they had at Chipotle, they'll pick and choose from a variety of offerings. ShopHouse probably has more vegetable offerings than Chipotle, and I think it's going to be able to provide the same kind of throughput, maybe if not a little bit faster than Chipotle. So I think we have the makings for success. Now the question when you determine to when or if you're going to open up another one. I mean, I think we'll be able to determine that certainly pretty quickly. I mean, just based on how well people like it. The economic model should fall into place pretty quickly. We're very good at that. So I think it's really a matter if people like it. There's so much attention kind of on one hand, unfortunately, on ShopHouse already that it's going to sort of cloud the reality of the situation in that. And then I think we're going to have lines out the door for the first few weeks. So I think we'll probably let things settle down and then watch to see how the repeat customers are using ShopHouse. But I don't think we have any preconceived notion of how long it will take to determine cost, if and when we'll open up another one. Sharon Zackfia - William Blair & Company L.L.C.: Are you feeding ShopHouse with restaurant-level personnel from Chipotle?

One Restaurateur will open and run the ShopHouse, just like one Restaurateur opened up the London restaurant and one Restaurateur opened up, is going to open up the Paris restaurant. They are all responsible for going out and hiring a crew with the same eye that our top Restaurateurs do at Chipotle right now, with an eye for hiring the future leaders of their own organizations or their patches, if you will. So it's really not a drain or a distraction to Chipotle. And it's exciting because it really gives people who are in the Restaurateur program an opportunity to take on a new exciting position and to take the Chipotle culture sort of to a new place. And at the same time, again, it just really doesn't distract the core business, which I think is very, very important and we haven't disrupted the core business with Europe, with Europe opening and we're certainly not going to distract the core business with ShopHouse opening.

We'll now hear from Jason West, Deutsche Bank.

Thanks, guys, and congrats on getting added to the S&P 500. Just want to follow up, while we have you guys together on the labor issues, you mentioned the U.S. Attorney's office getting involved, is that customary in terms of the types of investigations? Have you seen that with other companies that are involved with the ICE and then U.S. Attorney's office also takes a look at it or did that sort of surprise you the way that developed?

Actually, it did not surprise us, and the meetings we had with our consultants and with ICE, and from what we've learned since then, we've learned that it's quite customary for those agencies to work together and assist each other in investigations. And according to what the Assistant U.S. Attorney told us is that they had seen the media reports, they've read the papers just like everyone else, they had heard obviously what had happened in Minnesota and they felt that it was prudent for them to open a file, take a look, and "kick the tires" to make sure that they had discharged their responsibility, but that they didn't have any preconceived notion or believes that Chipotle had done anything wrong. So like I said earlier, we feel confident based on the way we run our company and the way we've always run our company that at the end of the day, the investigation will show that we're a good corporate actor.

Okay, that's really helpful. And in terms of the changes you guys are making with E-Verify and the I-9 and sort of just more vigilance across the platform in terms of hiring, will there be some cost either in G&A or labor that would be material this year for these activities? Or is it all kind of absorbed and not really something that would move our models around?

Yes, it's not something that's going to move the model around at all. The E-Verify tool is actually a free tool. There is no cost to using the tool and inputting the information will be done by our hiring managers at the store level. And it's a fairly simple process that takes very little time and gives a very quick result. So it's not going to delay our ability to hire people. It's not going to slow down our ability to onboard new employees, and so we're optimistic that it will not have any negative impact whatsoever on G&A.

Okay. And can you give us the number, what was the cost on Minnesota, just the final sort of run down on that cost for the quarter?

When the Minnesota situation first took place, or I should say, when we first had to remove 450 people and hire a whole bunch of new people and train them, there was a national 30 basis point cost. So in other words, Minnesota alone generated about a 30 basis point move in labor for a short period of time as we're training a whole bunch of new people who weren't as familiar with Chipotle as some of those folks who we didn't any longer have in our employment. So that situation has normalized to a good degree by now, come way, way down. Not quite so that it's at par with where it was before, but getting very close.

Jeffrey Bernstein of Barclays Capital is up next.

This is Sophia Siddiqi in for Jeff. Just wanted to ask about the labor scheduling tool and the prep deployment tool. Are you baking in any benefit from that into your estimate?

No, we are, and really, we don't look at those tools as ways of trying to save labor hours. We're looking at those tools as ways to help our general managers, assistant managers and crew in the restaurants to run the restaurants as efficiently as possible and with an eye towards excellent customer service. By way of example, our prep and deployment tool gives specific periods of time that it takes a high-performing crew person to perform all of the various tasks that we need to perform in the morning and then the early afternoon in order to get ready for our peak lunch and dinner periods. So the tool is very helpful because you have an estimated sales for each and every day. You take that sales, you divide it amongst lunch and dinner and you've got historical data to help you get -- estimate that very, very close. Given those sales, you boil that down to the amount of hours that you are going to be able to schedule in order to optimize the efficiency of your labor. But also, you have a very accurate picture as to exactly how many pounds of various foods to prepare for service. So we're able to perform the right amount of prep, not waste food, but also not have too little food such that we're scrambling to prepare food during our peak hour. What that allows us to do is a number of things, but importantly, we have all the prep done by the time our restaurant opens, such that all of our hands can be at the front line, serving you as the customer and not bothering with things that could have been done before or after the peak rush period. So our goal with the tool is to dramatically improve the customer experience by making sure that everyone knows what each other are doing, knows how long it's going to take to do it and so that we can also write schedules that do an excellent job of making sure that we have just the right amount of people coming in to get that work done. You see if we waste time by having, for instance, too many people come in during the morning for prep, that means that it's likely that, that manager will be trying to not use as many hours during the peak times a day and that might mean one or two less people on the line to generate excellent throughput. So if you can use just the hours you need to do your preparation, first of all, everything goes much more smoothly because everyone knows exactly what they have to do. But second of all, during the peak lunch and peak dinner hours, you have a line full of smiling faces that are relaxed and ready to serve you and that produce excellent throughput and a dynamite customer experience, and they've got all this time and attention to focus on that which they need to do during that time which is serve the customer. So we're really focused on creating a better customer experience, which we believe over time is how we're going to generate better and better sales and restaurant performance over the years for our shareholders.

Got it. And I just had a quick clarification on the commodities, are you still purchasing most of your commodities in the spot market?

Most of it. The only things we have locks, we have locks on corn for most of the year, rice for the entire year, our tortillas and beans for most of the year as well. So most of the ingredients, so our meats, our cheese and our avocados which are the things we invest the most in are floating.

And we have time for one further question. It comes from Andy Barish, Jefferies & Company. Andrew Barish - Jefferies & Company, Inc.: Just one kind of, I guess, clarification on your sort of pricing, thoughts or architecture as you look forward to the third quarter. I mean, historically, you've priced mid high-single digits on Food With Integrity, protein rollouts is -- obviously, you're still doing a lot of work on smaller items in terms of Food With Integrity. Is that the way you anticipate communicating pricing to customers? And does kind of California serve as a, maybe a benchmark for some of the pricing you're thinking about or is this state a little bit different because you're under-indexed as you mentioned?

Andy, you talked about pricing with Food With Integrity. That's frankly the way we've often done in the past and that's a great way to raise prices in a particular market when you have a new food story to tell your customers. Unfortunately, that's not what's driving the need for this price increase. It's more inflation driven, and so for the most part, we're going to have to be prepared to talk to our customers about the fact that, yes, we buy higher quality, more expensive ingredients, which are affected by inflation just like most items. And to keep serving these very high quality, great tasting ingredients, we're going to have to take menu price increases from time to time. So that's going to be more the message. California will help us a little bit, Andy, and that it will give us an idea in this environment. It will be the first or one of our very infrequent menu price increase that we've taken since the recovery began. And so it will tell us a little bit about how customers respond. But I don't think it's much of a gauge because California has been chronically behind. Cost of doing business there are higher than the rest of the country or most of the rest of the country, and yet they've just been historically behind. So we're not going to put too much stock in California because we're planning more catch up than we would be in the rest of the country.

And that does conclude our question-and-answer session. I'll turn the conference back over to our speakers for any additional or closing remarks.

Thanks for joining us today, all, and we'll be in touch in another quarter. Thanks.

Thanks, everyone.