Chipotle Q1'16 Earnings Conference Call: Full Transcript

Operator:

Good day and welcome to the Chipotle Mexican Grill Inc First Quarter 2016 Earnings Conference Call. All participants are now in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, today’s call is being recorded and I would now like to introduce Investor Relations Manager for Chipotle Mexican Grill, Mr. Mark Alexee. You may begin your conference.

Mark Alexee: Head, Investor Relations:

Thanks Matt. 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 2016 and you may also see it on our website at chipotle.com in the Investor Relations section.

Before we begin our presentation, I’ll 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 statements about our business recovery, planned marketing programs, and potential to recover lost sales, projections of the number of restaurants we intend to open, statements about future restaurant margins, projections regarding food, labor, marketing, promotion, and G&A costs, and statements about stock repurchases as well as other statements about of our expectations and plans. These statements are based on information available to us today and we are not assuming any obligation to update them. Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We refer you to the risk factors in our Annual Report on Form 10-K and is updated in our subsequent Form 10-Q for a discussion of these risks.

I’d like to remind everyone that we’ve 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 of 2016, it will begin June 1 and continue through our first quarter earnings release or second quarter earnings release planned for July 21.

We will start today’s call with some prepared remarks and then we’ll take 20 minutes of questions. On the call with us today are Steve Ells, our Chairman and Co-Chief Executive Officer; Monty Moran, Co-Chief Executive Officer; Mark Crumpacker, Chief Creative and Development Officer; and Jack Hartung, Chief Financial Officer.

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

Steve Ells: Chairman & Co-Chief Executive Officer:

Thank you, Mark, and good afternoon, everybody.

Chipotle has always been a company that is focused on a long-term vision to change the way people think about and eat fast food. As we move forward, we believe it is critical that we continue to focus on the things that have driven our success for so many years; our unique food culture and our unique people culture. It’s been our focus on these key drivers of our business that has differentiated Chipotle in a crowded and competitive field and has allowed us to develop a strong loyalty among our customers. These key attributes are what has allowed us to serve delicious food and to provide outstanding customer service. Never has it been more important for us to delight our customers on each and every visit and we have great confidence in our managers and crews to remain focused and to provide the extraordinary customer experience our customers expect from us.

We’re also encouraged by the long-term opportunity that still exists for Chipotle both in terms of adding new restaurants and attracting customers who have never tried our restaurants.

In each of these ways, there is still so much untapped growth potential for Chipotle and as we continue our efforts to restore lost sales tied to last year’s food safety issues, there is significant opportunity for us to continue to grow our business by attracting new customers and opening new restaurants.

We begin to see sales recover in the second half of the first quarter as our transaction trends reversed course from the lows we saw in January. Since the beginning of February, we have seen an 18 point improvement in comp transactions compared to the full month of January. We have worked to invite our customers back by reminding them of the things they love about Chipotle, such as our delicious food, our high-quality ingredients, and being treated to a friendly, fast experience inside of our restaurants. While we have used promotional programs to entice many of our customers to return, we are encouraged to see signs that the promotional traffic has translated into repeat paying customers.

Return of customers to our restaurants improved our same-store sales comps by 11% from January to recent levels. Of course, we would like to see our sales recover more quickly but we remain confident in our long-term strategy to welcome customers back into our restaurants.

Right after the food safety issues we encountered last year, we took several bold steps to ensure our food was as safe as it could possibly be. That included a systematic evaluation of each ingredient and the implementation of interventions to make them safer. Some changes were made at the suppliers and others were made in our restaurants. Since all initial changes were implemented, we have continued to evaluate and refine each procedure. Some of the procedures like blanching many of our produce items in the restaurant have proven to be very effective and our crews are doing a great job at executing these new procedures. In fact, we were able to add bell peppers to the blanching program which meant that we are once again able to slice the bell peppers in our restaurants rather than at a central kitchen. We have also refined the way we are washing lettuce which will once again allow us to cut lettuce in our restaurants while still ensuring it is safe.

We’re also continuing to refine many of the other procedures in ways that maximize safety while simultaneously making our food taste better.

During the quarter, we hired Dr. Jim Marsden as our Executive Director of Food Safety. Jim has been a tremendous asset as we continue to evaluate all of our safety protocols. Jim was previously a member of the faculty at Kansas State University in their Animal Science and Industry Department. He is working with a number of experts that have advised us in the past and has also worked closely with the US CDC and FDA and other food safety authorities as we continue to implement our industry leading protocols. Jim’s expertise and viewpoint has had a significant impact in a short period of time and we continue to look forward to his leadership in furthering our food safety program.

We recognize that it will take us some time to rebuild trust with our customers and to fully recover from the issues we faced late last year and while we are encouraged that the recovery is underway, we know that there’s still a lot more work to be done. We will continue to make it our top priority to entice customers to return to Chipotle through effective promotions and marketing. And when they do return, we’re committed to providing the very best experience that we can to help ensure that they will keep coming back.

We know that the very best marketing we can do is to provide an exceptional restaurant experience and our managers and crews are working hard to make sure they are doing just that.

I’ll now turn the call over to Mark.

Mark Crumpacker: Chief Creative & Development Officer:

Thank you, Steve. On November 1, we began conducting additional daily consumer research to help us measure and track consumer perceptions of our brand in the wake of the issues we saw last year. Key measures including admiration, consideration, first time visits, and food quality, are all continuing to improve. In some cases, consumer perception in these key areas has returned to levels close to what it was prior to Q4 of last year. For others, we still need to see additional improvements but the trends continue to be promising.

In early February, we launched an aggressive marketing campaign designed to drive customers back into our restaurants. This campaign consisted of mobile and direct mail promotions, a nationwide advertising campaign, and a variety of social, mobile, and local marketing activities. The campaign began with the RAINCHECK mobile promotion distributed on the day of our company-wide meeting on February 8.

As you may recall, this was the day we closed all of our restaurants for a national all company meeting and when we provided the opportunity for customers to get a free meal through our mobile offer. In all, we issued well over 5 million free burrito offers and saw an extraordinary redemption rate of 67%. We followed the mobile offer with a direct mail promotion to about 20 million households and we currently have a 17.5% average redemption rate which we expect to approach 20% as the redemption window closes. For those customers that had previously responded to direct mail, we are seeing a redemption rate of an impressive 44% and growing.

We are currently in the midst of our nationwide advertising campaign that runs through the end of June. This advertising campaign is the largest media spend in our history and is targeting all of our US and Canadian locations. The creative features, delicious food, and reinforces our commitment to responsibly raised ingredients cooked using classic cooking techniques and without the use of artificial flavors, colors, or sweeteners. Our research shows that this campaign is performing particularly well with new customers. In the coming months, we also plan to return to using nontraditional marketing that differentiates the Chipotle brand. This will include a short film and promotional game as well as other content driven marketing programs. These upcoming marketing efforts will combine differentiating messages about Chipotle with traffic driving components.

Throughout the year, we will continue to be more aggressive than usual with our marketing and we are considering two programs aimed at driving traffic among our loyal customers and lapsed customers that is customers who have not been to Chipotle in three months or more. For example, we are exploring a limited time frequency incentive designed to reward our most loyal customers for eating frequently at Chipotle this summer. Additionally, we are considering adding menu items that will appeal to our loyal or lapsed customers. Over the years, we have tested additions to the menu that have proven to be very popular with our most frequent customers. While we didn’t make these menu items permanent additions to the menu, at the time we do see an opportunity to introduce these or other items as a way of inviting our loyal customers back into our restaurants.

I’d also like to discuss the progress we’re making in strengthening our digital ordering capabilities. We have completed the integration between Postmates, our largest delivery partner and our back-of-house ordering system. This allows Postmates to send orders directly to our back-of-house make line instead of standing in line to order. We’ve completed this initial integration with Postmates and we are currently using this new system at restaurants in San Francisco and Atlanta, and will be rolling it out in all of our markets in the coming months. We’re also in the process of creating the same capability with our other delivery partners.

Next, we are testing a system that allows for smarter pickup times for customers who place online and mobile orders. This system is designed to reduce the time between order placements and pickup. The system dynamically monitors the flow of orders into our restaurants and gives our customers the shortest possible order completion time while simultaneously ensuring that the restaurants will complete the orders on time. This system is currently being tested in one of our markets prior to being rolled out nationwide. Finally, we issued updated versions of our iOS and Android ordering apps that make it easier for customers to pay using their credit or debit card to speed up the payment process and then streamline reordering for our frequent customers.

While it is early in our sales recovery process, we are encouraged by improving trends in customer sentiment and by customer response to our marketing and promotional efforts. We expect that we will see continued progress in these areas going forward as customers regain confidence in us and remember what it is that they always loved about Chipotle.

I’ll now turn the call over to Monty.

Montgomery F. Moran: Co-Chief Executive Officer:

Thank you, Mark. At the heart of our efforts to ensure the very best experience we can for each and every customer, are teams of top performing restaurant employees, managers, and field leaders. The strength of our teams has always been an advantage for us because these teams truly believe in our mission and treat our guests to a unique and genuine customer experience. As we continue to rebuild trust with our customers by serving safe and delicious food and as we continue to invite them back into our restaurants with our marketing and promotional programs, our restaurant teams are ready to provide the type of experience that will keep our customers coming back.

I’m proud of how our teams are responding in this challenging recovery effort. They have quickly and efficiently implemented many changes in our restaurants over the last few months and simultaneously continued to provide a terrific experience. I’m incredibly warmed by the level of commitment and pride our teams have demonstrated during a difficult time and I am more confident than ever that they are the ones who will ensure that we fulfill our mission.

Additionally, we are seeing the impact of stronger mid-level leadership through our improved rate of Restaurateur promotions this year compared with last year. Through the first quarter of 2016, we promoted 61 Restaurateur, an increase of 45% over the same time last year despite having even higher standards for the attainment of this elite position. We continue to refine the Restaurateur program, and while our Restaurateur candidates have always been required to show a demonstrable success in building Restaurateur cultures, delivering excellent hospitality, and ensuring a strong business model, we now have even more strict standards in all of those categories. Today, before a Restaurateur can be selected, they must have excellent scores on our internal and external third party audits related to food safety. And we continue to require more accountability for maintaining a disciplined business culture including assessments of sales projections, throughput, scheduling and labor management, food orders, and other management and key expenses. This business culture review is in addition to developing an amazing people culture, perhaps the most challenging aspect of being a restaurateur.

So with better tools and established field leaders, our pipeline of general managers continues to grow.

To continue to emphasize the development of our Restaurateur culture during difficult times is critical. They are the ones who can most skillfully create excellent, safe, and delicious restaurant experiences while developing the future leaders we need to grow our business effectively.

As we entice customers to return to our restaurants with more aggressive marketing and promotions, it is doubly important that we remind them what makes a meal at Chipotle so special by greeting them enthusiastically, having friendly and efficient service, great throughput, and by making them a delicious meal and the teams that are most able to do all these things well are our restaurateur teams who provide these great operations while ensuring a strong business model as well. As more restaurateurs are stepping up, our best field leaders have been able to spend more time in our newer restaurants or restaurants that have the opportunity to perform much-much better. With more field leaders in our system than in recent years, our restaurants are getting more one-on-one attention and leadership than before, and that will help to build more of these elite restaurateur cultures.

In addition to the accelerated pace of these promotions during the quarter, we also promoted 63 existing restaurateurs into multi-unit positions and strengthened our ranks by promoting 24 additional field leaders. This continued investment in our restaurateur and field leadership program is paying off in a better customer experience.

One example is the impact we’ve had on our throughput initiative. Our field leaders are working hard to set each restaurant up for success and that starts by effectively implementing the four pillars of throughput. When we have the four pillars in place, our restaurants are poised to engage with our customers and show our gratitude by serving them quickly on each and every visit. Our restaurants are prepared, organized, and ready for the day with proper meals on place. All hands are on deck with aces in their places, and with a dedicated linebacker that is in constant communication with the back of the house. And we can pull customers through the line faster with a dedicated expediter at the cashier.

Incorporating the four pillars affects nearly every aspect of the guest experience.

Of course, building great teams and great cultures in our restaurant starts with the people we hire and with our ability to retain and develop our top performers. That’s always the case but more so in a tightening labor market. We know that if our employees feel cared for and are given proper training such that they feel confident in their ability and encouraged by their circumstances, we have a much better chance of having them stay with us and develop careers at Chipotle. We are emphasizing this more with our restaurant managers and teams starting with the need to hire only crew members who have the 13 characteristics, the qualities we believe make it more likely that a newly hired employee will become a top performer at Chipotle.

We are also reiterating to our restaurants a need to involve crew in the interview process and hiring decisions for new crew. This helps us ensure that the people we are hiring in our restaurants are a good fit and it demonstrates the importance of each and every employee we add to our teams.

Developing future teams and promoting from within is extremely important to us particularly as we continue to bring Chipotle to more locations across the United States. During the quarter, we opened 58 new restaurants and for 2016 we plan to open 220 to 235 new restaurants. Looking beyond this year, there is still significant opportunity for us to continue to open new restaurants at a healthy pace. We will continue to balance the opportunity for further growth with a disciplined approach to development to ensure that we are opening up new restaurants in great locations with strong economics and staffed with top performing teams.

As many of you have experienced firsthand, our restaurants are feeling busy again. Relative to December and January, they have more energy, more customers, and enthusiastic teams ready to greet them. Our food tastes great and we are continuing to emphasize customer service and hospitality as we make headway in increasing our sales. That said, it’s more critical now than ever, that every restaurant delivers on the high standards that we have set for Chipotle. We have the utmost confidence in our crews, managers, and restaurateurs, as well as our field leadership to continue to improve upon these qualities that make Chipotle great.

I’ll now turn the call over to Jack.

John R. Hartung: Chief Financial Officer:

Thanks Monty. We invested aggressively during the first quarter to encourage our customers to return to Chipotle. Our customers redeemed over 6 million free burritos or goals during February and March and we also gave away nearly 1 million free orders of chips and salsa or chips and guac. The goal is to invite our customers back into Chipotle with a compelling offer, treat them to a delicious meal and an energetic environment with the hope that they will begin to return to their normal frequency of visiting Chipotle.

The response to the offers was strong especially right after our all company meeting on February 8 with redemptions reaching a high of nearly $500,000 in a single day just a few days after the offer began. Comp transactions improved from down 34% for the full month of January to a high point of down only 9% during the third week of February. Of course, it’s not surprising that free offers spurred immediate action by our customers, but more importantly, as the number of redemptions leveled off, we saw our paying customers steadily increase and by the first week of March when redemptions were down to under $100,000 per day, our comp transactions were down only 14% and comp sales were down 22%. We felt the recovery was off to a respectable start just three or four weeks into our marketing campaign.

As Steve mentioned, we implemented a number of new procedures and protocols to establish Chipotle as an industry leader in food safety. Some of these protocols are put to the test in Boston last month and we had four employees who were at home sick and fully followed our protocols by not coming to work. We temporarily closed the restaurant and local health officials commended us for the successful design and execution of our protocols which resulted in our restaurant remaining safe for our customers. Unfortunately, some stores referred to this as another outbreak and those headlines interrupted our sales recovery. This was a disappointing setback which caused our nationwide comp sales to worsen to around negative 27% for a few weeks before recovering to the low to mid negative 20s in late March. For all of March, comps TCs were down 15.6% and comp sales were down 26.4% with Easter negatively impacting both by about 2.5% as we lost one trading day in the month.

The impact of the headlines concerning Boston thought us that the recovery can be fragile and that we need to rebuild trust with our customers, every single customer, every single day, in every single restaurant.

Average daily sales increased sequentially in April versus late March by about 3% to 4%. But the comp sales run rate excluding the benefit of Easter was right around negative 26% in April so far because seasonality typically has resulted in about a 6% to 7% increase in April sales over March. Including the benefit of Easter, comp sales were around negative 22% for the first three weeks in April and comp transactions are around negative 16%. Easter added about 4% to both the sales and transaction comps so far.

Now, some of this lag in April sales are due to cold wet weather in some areas of the country early in the month and we did see the comp for a few days improve to the low negative 20s during the past week so we’re hoping we will still get that seasonality step up we normally see this time of year but just a few weeks later.

The sales recovery has been uneven throughout the country. For the first three weeks of April, our traffic comps, excluding the Easter benefit, were negative 15% in the middle of the country, the Southeast and the Mid Atlantic, whereas they were down 20% company-wide again excluding the benefit of Easter. That’s about a 16 point recovery as compared to January which means we recovered about half the lost visits in these areas. But on the West Coast and the Northeast, the two areas closest to the outbreaks of late 2015, our traffic comps have recently been trending at negative 24%, again excluding the Easter benefit compared to negative 37% in January. So we’ve only recovered about a third of customer visits in these areas.

For the first quarter, sales were $834.5 million and our restaurant level operating margins were 6.8% for the quarter. As expected, the largest driver of the year-over-year decrease in margin was sales deleverage which accounted for more than half of our drop in margin compared to 2015. There’s also an impact of nearly 600 basis points of what we would consider to be nonrecurring expenses including an elevated promotional and marketing investment that totaled 660 basis points which is over 500 basis points higher than last year.

Food cost is higher than Q4, 2015 by 150 basis points and we expect that food cost will remain at about this level for the rest of the year.

While it’s difficult to provide meaningful projections for either sales comps or margins in the coming quarters, especially given the sales volatility I just described, I can tell you that the approximate margin level to expect at various sales levels. For example with comps at the current level, our average unit restaurant volumes are about $1.9 million on an annual basis and our restaurant level margins should improve to the low double digits in the next few quarters as the nonrecurring costs begin to level off. If comps are around negative 20%, AUVs would be about $2 million and margins would be around the mid to high-teens. If comps recovered around negative 10%, AUVs would be about $2.2 million and our margins should be in the low 20s and if we fully recover our sales with AUVs in the $2.4 million to $2.5 million range, we would expect margins in the mid 20% range which accounts for the recurring cost of new procedures and protocols that relate to food safety.

Labor costs for the quarter were 30.9% of sales or an increase of 850 basis points compared to last year. More than 600 basis points of the change was driven by sales deleverage, while we also had nearly 100 basis points tied to nonrecurring expenses as we incurred additional labor in early February and March to support our promotional strategy and also our national team meeting on February 8 when about 50,000 employees attended. We also continue to incur higher labor costs related to our merit increases taken in mid 2015 for restaurant crew and managers which averaged about 7% along with increased benefits including increased vacation days, paid sick leave, and tuition reimbursement, all of which added about 160 basis points to labor.

Our promotional and marketing expenses during the quarter totaled $55 million or about 6.6% of sales and this included $4 million or about 50 basis points related to promo offers that were issued in the first quarter, they’re expected to be redeemed in the second quarter. We’ll continue to invest in recovering our customers and promos will be an important part of the strategy but we expect combined marketing and promo to level off to about 3% to 4% as a percentage of sales over the next few quarters. While this is lower than Q1, it’s nearly double what we spent as a percent of sales in Q2 and Q3 of last year. We’ll invest in more traditional brand advertising and return to talking about our delicious food made from high quality ingredients.

G&A for the first quarter was $62 million or 7.4% of sales, down $1 million from last year. Total stock-based comp included in G&A was $7.5 million which is down about $7.6 million from last year. Offsetting that reduction were higher legal costs and the cost of the all company meeting which combined added $4 million to G&A. For the full year 2016, we anticipate total stock based compensation in G&A to be about $60 million and for the full year 2016, G&A will total just over $300 million or about $50 million higher than last year as we add support for our new restaurant openings and as we will hold our biennial all manager conference in September.

Our effective tax rate benefit for the quarter was 40.6% and was impacted by nonrecurring adjustments related to state income taxes for prior years. Our effective tax rate for the full year is expected to be 38.4%.

During the first quarter, we reported a loss of $26.4 million or a diluted loss per share of $0.88.

Our cash and investments totaled $706 million as of March 31 and we continue to be very aggressive with our balance sheet to repurchase stock. We repurchased a total of $645 million from January 1 through yesterday at an average price of $463 per share. Since November 1, 2015, we’ve repurchased a total of $956 million of our stock, representing a reduction of nearly 2 million shares outstanding and we have $71.4 million left in our current authorization to purchase stock.

As we work through this sales recovery, we will remain disciplined in restoring our unit economics to deliver attractive margins and returns and restore our ability to create significant shareholder value over the long-term.

Thanks for your time today and we’d be happy to open the line for any questions you may have.

Question & Answer

Operator:

[Operator Instructions] John Glass with Morgan Stanley. Please go ahead.

John Glass: Morgan Stanley:

Thanks very much. If I could, just two. One is, first, can you just talk about currently what portion of your sales are on coupons? I think you’ve talked about that in the past with the rate of, how reliant are you currently on coupon redemptions, what portion of the sales, and how have those trended over like last four weeks as you’ve sort of moved away from some of the initial drops?

John R. Hartung:

Yeah, John. It’s dropped off a lot. If you look at the difference between during April between our sales and our transactions which is about a 4% to 5% difference, that would account for the people that are coming in and have a coupon and are not -- basically it’s reducing our average check. So I would call it in that 4% to 5% range.

John Glass:

4% to 5% of transactions or of your total comp are coming from that?

John R. Hartung:

Well, there’s a gap between the comp sales and the comp transactions and that gap is all driven by a lower average check and most of that gap is driven by the promotions. So part of it is driven by a lower check size but the largest part of it is driven by the promotions. So I’d say the promotions are in that kind of the 4% range in terms of sales. Those are sales, John and had they been coming in full paying customers, there would be virtually no gap between our transactions and sales.

John Glass:

Got you and I know you gave some scenarios around where store margins would be at various comp levels. Can you talk more specifically about the second quarter specifically and knowing now a little bit more specifically about the promotional activity you’re doing and the expense related to it, do you have a sense of where second quarter earnings comes out based on all of that? I understand there’s some comp sensitivity, but is there anything specifically to call out in terms of the cost structure in the second quarter versus the first quarter?

John R. Hartung:

John, I hesitate. The first quarter we gave a figure, we said we were going to lose a dollar, and that’s because we knew we had a lot of one time things. We were implementing our food safety protocols. We’re not prepared, I’m not prepared to guess what the EPS is going to be in the second quarter. It all depends on sales. So as sales recover, the EPS will turn positive very quickly, and we’ll have a reasonably healthy EPS but if they stay at this level, it’s going to be hard to deliver the higher margins. It’s going to be hard to deliver the EPS. So we’re not going to give an EPS projection at this time.

John Glass:

Got you. Okay. Thank you.

Operator:

we’ll go to Sharon Zackfia with William Blair.

Sharon Zackfia: William Blair:

Hi. Good afternoon. I guess a couple of questions for Mark. I think you mentioned in your prepared commentary that some perception areas with consumers are lagging. I wonder if you could talk about what the laggers are and how you’re going to address those and then secondarily when you talk about your most loyal and most frequent customers, can you define how you kind of characterize those? Are those folks coming once a week, just any kind of parameters around that. And then it sounds like they have been lagging maybe more than the less frequent customers. If you could give some color around that, that would be helpful.

Mark Crumpacker:

Sure. With regard to the brand attributes, they’re all actually looking pretty good, but I’ll give you a few examples. Aided consideration, so obviously when we give people a list of restaurants including our brand and ask them how likely they are to visit, before the food safety issues that hovered around 50%. Right now that’s recovered to 43%. So we’re down 7% on that one but it’s picking up at a consistent rate. Admiration before these incidents was 70%, now it’s at 61%. So again, recovering from down into the 50% area. So a lot of the stuff has come back up nicely.

The way we measure new customers, of course, are the people who visited for the first time within the last three months. That’s actually recovered almost, it’s just two points below what it was before this so that’s really good news. On the customers who are lapsed, we look at people who haven’t been in three months or more and that was, you want a lower number there, that was 49% before and now that’s at 57%. So that one’s probably got, that’s got the biggest delta there. But for example, on another attribute which is we serve healthy, fresh, unprocessed food, that’s recovered to exactly the same levels as it was before. So it’s a mixed bag. I don’t know that any of them are problematic such that I don’t think we’re going to be able to recover them so we’re seeing just nice trends all across the board on those.

In terms of your question about frequency, we break our customers into five groups by frequency. We call our most frequent customers top loyal they come 25 times or more a year. The next group are heavy customers, they come 13 to 24 times, then medium which is 6 to 12, light is 2 to 5 and a new or lapsed customer is one time. And you are correct in that we saw larger declines in both new, in the two top and bottom categories. So these are single digit drops in new and lapsed and in top loyal. And so a lot of what we’re looking at from a marketing perspective is bringing in those top loyal -- that single digit drop in top loyal customers that we saw and I’m not suggesting that these customers left altogether, but their frequency may have declined. So some of what I mentioned in my prepared remarks are aimed at either giving them a reason to come back in and that might be a new menu item or some sort of a frequency incentive which I also mentioned which would be coming in a certain number of times over a period of time, and we will give you something. So those are both efforts designed to target that group of customers.

Operator:

Joshua Long with Piper Jaffray.

Joshua Long: Piper Jaffray:

Great. Thank you. So I wanted to see if you could provide some commentary on how you’re thinking about balancing the aggressive advertising and traffic driving initiatives over the near term with maybe balancing the longer term value or consumer perception over the longer term.

Mark Crumpacker:

Well, we are transitioning, first from free to buy one get ones and other types of promotions which typically have a purchase associated with them as a transitional step away from being entirely dependent on free food. So that’s part of it. But as I mentioned also in my prepared comments, we’re getting back into the type of advertising or marketing that’s been so successful for us in the past, which is some of this brand marketing which is based on short films and other types of content which really deliver messages about the brand and continue to differentiate Chipotle from the competition.

One of the really good pieces of news in our research is that the differentiation of Chipotle from our competitors really has not suffered or to the extent that it did, it recovered fully and so we’re going to continue to push the messages about our 65 ingredients and how simple they are and our simple, classic cooking techniques and how different that is from the competition whose food is, tends to be heavily processed and include hundreds and hundreds of ingredients, many of which are processed. So we’re definitely getting back on that. In July is when we’ll really be in full swing with that type of marketing again. So we’re transitioning back. But as I say that, there’s going to be always a promotional element with those until we really fully recover our sales.

Joshua Long:

Understood and then as we think about your discussion about bringing new menu items in, should we be thinking about those as LTOs here over the near term or perhaps permanent menu additions and how do you think about balancing the, maybe added complexity of new menu items which you haven’t done or haven’t been as big part of the story historically with your focus on really driving operational efficiency here over the near term?

Mark Crumpacker:

Okay. Well, I’ll speak to whether or not or how this might unfold then I’ll let Steve talk to the nature of the operational impact to it. But right now, I wouldn’t say whether or not -- I don’t think we know whether or not these things would be permanent but there’s no reason why they wouldn’t be. The item that we’re considering introducing first is chorizo, which is something we’ve done before. We did it in Kansas City last year and we were prepared to expand that to a second market right as we came into this food borne illness situation and we tabled it so that we could put all of our focus on correcting the problem. But we did find that that was very, very popular with our loyal customers. In fact, for a lot of people who tried it, it quickly became their most favorite protein and so it’ll be very helpful for us from a marketing perspective to bring those customers back in and make our loyal customers come more often. So I think it’s yet to be seen whether that means it will become permanent but we’ll try it out and see how it goes. Steve can talk to the nature of that and how that works within the Chipotle environment.

Steve Ells:

Sure, Mark. Josh thanks for the question. So this chorizo that Mark speaks of is really delicious. It’s a chicken and pork spicy sausage. We cook this on our plancha. It has lots of little crispy bits. So it has nice spice and really good texture, and as Mark said, very, very popular with the customers that had it in a couple of our test markets. When we think about adding something to Chipotle, we’re very, very mindful of our overall efficiencies; efficiencies in the kitchen, efficiencies in cook time, efficiencies in throughput and ease of ordering for the customer. Chorizo fits into this system really, really well in that we have space for it on the main line and it doesn’t detract from throughput. It’s also very easy to rotate on to the plancha to grill between chicken and steak. The cook time and the method of grilling isn’t much different from the chicken and steak already on the plancha. So operationally, I would say it’s quite easy to execute. But I think it’s very exciting, in that it does add a new flavor and texture to the meat offerings and it pairs well with our existing offerings, our salsas, and guacamole and cheese, and what have you. So again, very popular and I’m excited to see how this works.

Joshua Long:

Great. Thanks for taking my question.

Operator:

John Ivankoe with JPMorgan.

John Ivankoe: JPMorgan:

Thank you. Two questions, if I may. Firstly, with some of the food safety changes that you’ve made, the sous vide of the steak, blanching a variety of vegetables and precutting lettuce, have all of those changes been met with the positive customer response? In other words, do the customers like the food as much or better than they did before the operational changes that you found yourself to make?

Montgomery F. Moran:

Yes. I think generally, the changes have gone very, very well. I won’t say all of them have been met with immediate approval. An example of that is we went over to a lettuce that was pre-shredded at a central kitchen in order to be able to be absolutely certain that all the interventions were in place to make sure that that was food safe. And that lettuce, I think, people found to be a degradation in quality of the stuff that was cut in the restaurants by our teams who -- when our restaurant teams do it, they’re able to cut it to the exact size they want, they’re able to really make sure that the presentation is exactly what they want and that they can assure the quality of the lettuce. This was a product which is really just completely prepared in central kitchen.

So what we’ve been able to do and what we’ll be rolling out soon, we’ve been able to find a way to have this made completely safe by interventions in a central kitchen but yet still have the entire head of lettuce brought to the restaurant and give our crews in the restaurant the latitude to be able to cut that properly and assure the quality of that again. So we’ve just been tasting that the last few days in a few of our restaurants here in Denver, and it’s delicious, it’s wonderful, and so we’re going to be moving back to a lettuce that I think everyone else is very satisfied with.

The rest of the changes have been met very positively. The sous viding of the steak is delicious. We’ve actually had a reduction in the number of customer complaints. With steak, there’s always been over time some complaints because steak contains naturally some chewy bits and what not because we use real steak. And with the sous vide, the technique has allowed us to break down some of those aspects of the steak through a kind of a long breathing process in the sous vide process which makes the steak juicier and more tender and more delicious. So actually we’re very, very pleased with how that’s going and our customers seemed to be very pleased as well.

The blanching of the ingredients essentially has had no effects whatsoever on the eating part of the ingredients but it’s a wonderful step to ensure, again food safety and the elimination of potential harmful pathogens or what have you. So our crews in the restaurants have done an awesome job implementing that new procedure and have found it quite easy and they’re very proud of it because it makes them, it gives them even higher level of confidence in the food we’re serving and again, no degradation whatsoever in what our customers are receiving. So we are feeling really, really good about the quality of our food in the restaurants. I think it is actually better than ever, I think, subject to that one change in lettuce.

We thought that the bell peppers we were bringing in pre-sliced from a central kitchen were good, but maybe not quite as good as the ones cut in our restaurants. So what we’ve been able to do is go back to blanching the bell peppers such that they can be cut by a knife by the skilled hands of our folks in the restaurant and again have brought that back to the level of quality it was before but again with the blanching to assure food safety of that ingredient.

So we’re very proud of everything we’ve done. We think that the intent focus on our food that’s been caused by looking at every single ingredient, it’s caused our teams in the restaurants to also look at every single ingredient very, very critically and make certain that everything is as good as it can be. So I think our food is more delicious than ever. With that one sort of asterisk that the lettuce was I think not as good for a time but we’re returning that to where it was and I think that we’re very, very proud of where our food stands now.

John Ivankoe:

Okay. And Monty, you made a comment in your prepared remarks and it was interesting how you said it, talking about a unit development in 2016 and basically seeing beyond this year, continue to grow at a healthy pace and I think you used the word disciplined pace around location, returns, and staffing. I’m sorry I don’t have the transcript in front of me. But it seems like you may be kind of preparing us for a slowdown or a leveling off of development from ‘16 into the outer year. So I just wanted to see perhaps what you meant by those comments.

Montgomery F. Moran:

Yes, thanks for asking. I think the short answer is no. We’re not preparing for a slowdown of our development and I think you’ll find that we will be able to achieve very easily the guidance that we’ve given in terms of number of restaurant openings. But we do have a very strong pipeline coming in from our real estate teams who have been doing an excellent job finding a lot of terrific sites. But the reason for my comments was that as we’ve had a slowdown of sales overall that you’re all aware of, and the numbers that Jack spoke about with a slowdown of nationwide sales as a result of what happened in late 2015. So too has that slowdown affected our new store openings. But it’s affected them disproportionately.

What I mean is that most of our new restaurant openings have still held the same percentage that they historically have held versus our trailing 12-month sales of our existing stores. But the exception is in the new markets and developing markets. In those markets there’s been, I think, even more softening of their sales than there has been nationally, say. So the delta between a new store openings in a developing or new market, has been slightly greater than when you compare it to the rest of our restaurant average daily sales. So the delta of new and developing markets is a little bit bigger than the delta between proven and established markets. And so that percentage of all of our newer store openings though it’s quite low, it’s about 13% of our new store openings are in new markets or developing markets. And because those sales have been correspondingly a little more soft than the rest of the openings, we’re going to be taking just a much closer look at those and be more nitpicking as to which ones we do deals on.

So it’s going to be a very slight effect in terms of number of openings, and we have such a strong pipeline that we don’t think it’s going to affect the overall numbers that we’ve shared with you that we plan to open. But it’s going to give us I think the ability to be a little bit more discerning on a few of our locations and just make sure that any ones for which the development cost is perhaps a little bit high or the rent structure isn’t quite advantageous, we might walk away from some of those deals that we might have pursued a year ago today, for example, just to be responsible with our investments.

John Ivankoe:

Thank you.

Montgomery F. Moran:

Thank you.

Operator:

Jason West with Credit Suisse.

Jason West: Credit Suisse:

Yes, thanks. Jack, just wanted to come back to the guidance that you talked about on the promo and marketing expense going forward. You said you want to get that down to 3% to 4% of sales I think over the next few quarters. I believe it was over 6% in the first quarter or so. Are you guiding us to promo marketing in sort of 2Q, 3Q in the 5ish type range or is it not going to be that much of an impact? If you could help us there, it’d be great.

John R. Hartung:

Yes. No, I’d mentioned it’d be in the 3% to 4% range. Now, keep in mind our sales during the second and third quarters are higher. So you’re talking about a 3% to 4% figure on top of higher sales. So it’ll be meaningfully reduced and what you’ll see is that reduction is going to be in the promo. We hit promo as you know, very, very heavy. We gave away about 6 million entrees during the first quarter and we did that intentionally. We wanted to hit that really hard, we wanted to signal that event was over. We signaled that within a week or two after the CDC called their investigation over and so we did that intentionally.

Going forward, as Mark mentioned, we’re going to be transitioning to more which have a lesser impact on our promo line. Offsetting that, we’re actually going to spend more on advertising during the second quarter for sure, probably third quarter. But overall, expect that to be in the 3% to 4% range. Now that’s still higher than historical because if you look at second quarter and third quarter of last year, I think that’s right around double or a little more than double what we did as a percentage of sales last year.

Jason West:

Okay and is that number still though TBD, depending on the sales that you’re seeing? So I mean if your comps are not progressively improving, is that a number you’re going to come back and revisit or do you guys feel like that’s the type of number that’s really going to get the sales going?

John R. Hartung:

Oh, no. Listen, we’re not locked to a number at all. That just happens to be a number based on the next wave of the strategy. We’re moving into more brand advertising, moving into more of the BOGOs. That just happens to be the number. We’re prepared to do what we need to do to continue to invite customers in, to continue to give them a great experience, and so if we needed to invest more, if we thought that would be a good investment, we would certainly make it. But right now, we’re thinking it’s going to be in that 3% to 4% range.

Jason West:

Okay and Mark, can you just explain a little bit on the loyalty piece that you mentioned how that’s going to work and is that a temporary program or not?

Mark Crumpacker:

Yeah. I don’t have enough details to tell you exactly how it’s going to work right now. But it is a temporary program. We’ve seen and I mentioned earlier is that there’s been a slight decline with our most loyal customers in the number of times they actually visit Chipotle per week and so we would love to get that, have it back up. And so this was a way and we’ve got a couple of different technological ways of doing it. So I don’t really want to go into those because I’m not sure which ones or if either will prove to be completely viable. But we do believe it’s beneficial to us to get people back into the habit of visiting Chipotle at a frequency level that they enjoyed prior issue. So it would be something that we would do through the summer and perhaps into the fall but not something that would become permanent. There is of course always the possibility that we would create some sort of a permanent program but that would take more time and planning and so this is a temporary one for now.

Jason West:

Thank you.

Operator:

Jeff Farmer with Wells Fargo.

Jeff Farmer: Wells Fargo:

Thanks. Jack, I just wanted to better understand or confirm some of the numbers you discussed today. So I think you said that April same store sales, at least to date, are down 22% but that included the benefit of an Easter shift and had we excluded that benefit from the Easter shift, it would’ve been down about 26%. Is that correct?

John R. Hartung:

That’s correct.

Jeff Farmer:

Okay. So I guess that then the question becomes so that down 26% sounds like it’s essentially in line or even a modest sequential acceleration of same-store sales decline from what you were seeing at the end of March. If that is the case, how do you explain that?

John R. Hartung:

Yes. Jeff, it is because we saw early March was down 22%. Then we had the news coming out of Boston. Our sales spiked up to or spiked down to down 27% for a couple of weeks near the end of the month, and you’ve got a lot of choppiness with Easter this year at the end of March, and then you compare it to Easter last year in early April. But we are starting to see recovery back into that low to mid 20% range at the end of March. Our sales dollars, when we moved from the end of March to April, got better. They improved by in that 3% to 4% range, but we’re comparing to seasonal sales that in the past and last year kind of followed the pattern of increasing more like 6% to 7% range.

So our dollars moved up Jeff from March to April from late March which is in that low to mid 20% range. Our dollars from that range moved up in April but because of the tougher comparison, our comps did retrench a little bit and they moved back to 26%. Now, in the last week, we’ve seen a number of days in a row. It’s not a pattern yet but we’ve seen a number of days in a row that have gotten back into that mid to low 20% range and so we’re hoping that maybe seasonality just is showing up a little bit late where we’re going to get that bump. We do know that there was some cold and some wet weather throughout parts of the country early in April and so we’ll see whether we’re going to get this step up or not. But, yes, our comps did get worse, but our sales dollars did continue to move up from March to April.

Jeff Farmer:

Okay. And then just one more; I know you’re reluctant to provide Q3 EPS guidance, but is the potential for this to be another loss? It seems like that would be, at least in my opinion, a little bit surprising given just the sheer magnitude of the promotional costs that you were throwing at this business at Q1, including a lot of the costs that were basically headed toward the Q2 transactions. So, again, understanding the reluctance, is that in the realm of possibility or…

John R. Hartung:

I would not -- yes. Jeff, listen, it’s so hard to predict because I gave almost excruciating detail about the sales during the quarter and then in April just to give you an idea of how volatile it is, how tough it is for us to see, is the recovery taking hold and then it gets interrupted by a news out of Boston and so I wanted to give you as much detail as possible. So with all that volatility, it’s hard to predict. But I would not expect a loss in the second quarter. I would expect such because we have fewer of the one-time costs, because I would expect to see some recovery, because second quarter is seasonally a better quarter for us compared to the first quarter, I would not expect to see a loss in the second quarter.

Jeff Farmer: Wells Fargo:

Okay and then can I sneak in just one more real quick?

John R. Hartung:

Sure. Now you’re going to ask me what EPS is going to be in the second quarter, aren’t you?

Jeff Farmer:

No, no, no, not at all. Just on the labor line, I just looked at this one. So look, we all sort of look at the dollar costs for operating week numbers. Looked like you did a pretty good job of, at least they fell year-over-year. So the question becomes, I know you pointed to going back to over the last quarter that some inefficiencies surrounding both staffing the restaurants and managing food waste. I’m just trying to get a better hold on your ability to sort of maximize efficiencies or minimize those inefficiencies I should say, in terms of both labor scheduling and controlling your food waste. Do you guys think you’ve made some big steps?

John R. Hartung:

I wouldn’t say we have, Jeff. I know there’s inefficiencies in there. We’re really not going to go hard after them. When you look at labor for example, labor is worth I think 850 basis points. Of that 600 basis points of that is deleveraged because of sales and so the most important thing we can do is get our sales back. Another 100 basis points is due to the very heavy promo that we did in the first quarter. So we had a lot of people visiting, a lot of people dining at Chipotle but they didn’t pay for all or part of their meal. Yes, we have to staff the restaurants, so there’s about 100 basis points of that and then there’s another, I think, it’s 150 basis points to 200 basis points or so of what I’ll call inflation. It’s stuff that we did last year. We had merit increases for our managers and crew. We rolled out or introduced a education program, college education or education but usually college education. We started to pay for sick pay and then we enhanced our vacation pay. So those are all inflationary things that were in that kind of 150 basis points to 200 basis points range. So those are the big pieces.

Underneath all that, is there some efficiencies? Sure, but maybe that’s 100 basis points or so. We don’t want to go out and squeeze labor right now and drive those efficiencies at a time when what’s most important is for us to have a fully staffed team, to have the four pillars in place, have a team that feels ready to greet customers when they come in and hopefully at an accelerated rate and so I wouldn’t want to go after 100 basis points on the labor line when what’s most important is to have a great experience and let’s encourage the sales to happen.

Jeff Farmer:

All right. It makes sense. Thank you.

John R. Hartung:

Great. Thanks, Jeff.

Operator:

We’ll turn it over to our host for any additional or closing remarks.

Mark Alexee:

Thanks everyone for joining the call today. We look forward to updating you on our second quarter conference call planned for July 21. Thanks again.

Operator:

Again, this does conclude today’s conference call. Thank you all for your participation.