Earnings Call: Q4 2012

Feb 5, 2013

Good afternoon and welcome to the Chipotle Mexican Grill 4th Quarter 2012 Earnings Conference Call. All participants are now in listen mode only. After the speakers' remarks, there will be a question and As a reminder, this conference is being recorded. Thank you. I would now like to introduce Chipotle's Director of Investor Relations, Alex Fong. You may begin your conference. Thanks, Angela. Hello, everyone, and welcome to our call today. By now, you should have access to our earnings announcement released this afternoon for the Q4 full year 2012 and 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 laws. These forward looking statements will include projections of the number of restaurants we intend to open, comp restaurant sales increases, food cost trends, effective tax rates, investment costs and capital expenditures as well as statements regarding potential menu price increases and other statements of our expectations and plans. These presentations 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 forward looking statements. We refer you to the risk factors in our annual report on Form 10 ks as updated in our subsequent Form 10 Qs for a discussion of these risks. Our discussion today will also include non GAAP financial measures, a reconciliation of which can be found on the presentation page on the Investor Relations section of our website. 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 1st day of the last month of each fiscal quarter and continues until the next earnings conference call. For the Q1, it will begin March 1 and continue through our Q1 release in April. 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, Alex. We're pleased with our results for the Q4 of 2012, as well as our performance for the full year. While higher than expected food costs impacted our earnings, our top line performance for the quarter was strong with a comp sales increase of 3.8% and total revenue increasing 17.2 percent to $699,200,000 adding up to diluted earnings per share of $1.95 for the quarter. Results for the full year met or exceeded the guidance we provided in every area, including a comp sales increase of 7.1% for the year and total restaurant openings of 183, 60 of which were opened in the Q4. Our strong openings and comps drove revenues to $2,730,000,000 for the full year, an increase of 20.3 percent over 2011 and diluted earnings per share of $8.75 The continued strength of our performance is a direct result of our focus on the most important things that drive our business, primarily our unique food culture and unique people culture. With Grougarde du Car Food, we're always pushing ourselves to find better, more sustainable sources for all of the ingredients we use and to refine our preparation and cooking techniques so that we're offering our customers the very best tasting food we can. And with regard to our people, we continue to develop a culture where we systematically focus on identifying top performing employees and develop and empower them to become the future leaders of our company. Through this culture, we're ensuring that we have the talent and leadership we need to continually improve our existing restaurants and to open new restaurants with the highest of standards. Through this special culture, we are providing leadership opportunities for all who join the company. Heading into 2013, we're launching a new catering program to give customers a different way to experience Chipotle. Catering is now available throughout the Colorado market and will be rolled out to all of our restaurants nationwide in the coming months. Our catering menus are available for groups of 20 to 200 people and include everything customers need to make their own tacos and bowls, including the choice of responsibly raised meats, cilantro lime rice, pinto or vegetarian black beans, fresh salsas, house made guacamole cheese and sour cream. It's been exciting to see people enjoy Chipotle catering for the first time when they realize they have the to serve themselves through a smaller version of the Chipotle line and create their own special meal with exactly the combination of ingredients and portions they want. Even though our customers appreciate that they can customize their meal when they visit Chipotle, this is their first hands on experience serving up our delicious ingredients. For customers who want a smaller option, we are also offering a chips and salsa spread, which includes guacamole and a variety of salsas. Or for smaller and more streamlined catering orders, customers can choose our burritos by the box option, which allows them to mix and match their choice of chicken, steak, barbacoa, carnitas or vegetarian burritos. These burritos come with white or brown rice along with black beans, fresh tomato salsa and cheese. Burritos by the box includes chips, tomatillo green chile salsa, guacamole and sour cream. We've also created a new menu item called Sofritas, which will be available in our San Francisco Bay for the first time next week. Sofritas is a delicious and flavorful vegetarian option made with shredded organic tofu. It's braised with roasted tomatoes, Chipotle and poblano peppers and a blend of aromatic spices. We'll explore options for expanding Sapritos to other markets based on customer reaction in the Bay Area. We'll keep you appraised of our progress with both Saphrita's and catering as we progress throughout the year. Our marketing this year will continue to focus on building the Chipotle brand and will also include heavier emphasis on driving traffic and encouraging trial than it did in the past year. Marketing programs this year will include a significant ad buy in many of Chipotle's markets beginning in March, including radio, print and outdoor. Additionally, we have significant well developed local sales building plans in 25 of our best markets. We will strengthen our brand and develop a deeper relationship with our customers through our successful non traditional marketing techniques. This year, we'll continue to build our signature Cultivate event series by hosting events in Chicago, Denver and San Francisco. And following up last year's successful Back to the Start animated short film, we're developing new content programs that will continue to strengthen the Chipotle brand and that spark conversation and important issues relating to food. We continue to plant seeds for future growth opportunities with our international expansion and with Shophouse. Currently, we have 12 international restaurants and 1 Shophouse. Of our international restaurants, 5 are in Canada, where we started almost 5 years ago, 6 in London, where we started over 2 years ago, and 1 in Paris, which just opened last year. In 2013, we plan to add to our international portfolio with 4 more restaurants, one of which will be in Germany. We currently have 1 shop house in Washington, D. C. And plan to expand there with 1 more restaurant in the Q2 and also open our first in Los Angeles also in the Q2. Our focus on our international expansion has been introducing the Chipotle brand, establishing relationships with like minded suppliers and developing leaders to support our expansion. We continue to run all of these restaurants without significant infrastructure under the leadership of a few restaurant tours, while hiring and developing empowered teams of top performers to support potential future growth. I'd like to compare our international expansion approach to the way we look at growth in the United States. Growth in the U. S. Has been done with what we call our portfolio strategy, where the majority of our new restaurants are opened in our proven markets. Proven markets are those where the Chipotle brand is well known and where we can accurately predict how well new restaurants will perform. Investing in these proven markets has provided strong and reliable returns and has allowed us to allocate a portion of our capital to new markets and to developing markets knowing that these markets may not currently be as strong as our proven markets, but with confidence that they will develop and transition into proven markets. This happens as the Chipotle brand becomes better known and accepted. As we apply this same portfolio strategy to international, all of our markets outside the U. S. Today would be considered new markets where the Chipotle brand is still being discovered. Canada has been open the longest with our first restaurant opening in Toronto almost 5 years ago, And Toronto is well on its way to being considered a proven market, with volumes similar to those in the U. S. And with margins and returns not far behind. London was our 2nd international market with our 1st London restaurant opened in about two and a half years ago, and 4 of the 6 London restaurants have been open less than a year. And while we're proud of the team in the Chipotle restaurant experience in London, our awareness there is still quite low. And so our London volumes are much lower than our restaurants in the United States and Canada. We recently completed a research study in London to help us better understand customer perceptions about our brand and about our competitors. The results from this research show that customers who have visited Chipotle really like the food and the overall experience, but the research also indicated that unaided awareness of Chipotle among fast casual diners is very low, only 1% compared with 16% for Pret A Manger or 23% for McDonald's. Aided awareness for Chipotle is only 34% as compared with 97% from McDonald's, 94% for Subway and 91% for Pret A Manger. The top reason listed for not visiting at Chipotle was lack of a known location. Given our low awareness, it's not surprising that our sales in London have started out slow. However, this is very reminiscent of our initial entry into many new U. S. Markets. It's also to note that research also indicated that customers are hearing about Chipotle via word-of-mouth at nearly twice the rate than our direct competitors. We find this very encouraging as it also mirrors our trends in the U. S. And suggests that once people visit Chipotle, they become loyal customers. Moving forward, we plan to increase our marketing efforts in London in order to increase awareness of the Chipotle brand and encourage customers to visit. While Paris is still very new, we're encouraged by the customer feedback so far and we'll learn more as our second restaurant opens early this summer. Our non Chipotle growth seed, Shophouse in Washington DC continues to perform well and reminds me very much of the first Chipotle when I opened it almost 20 years ago. Customers immediately noticed that it's very different from the typical Asian offerings out there, much in the same way that they noticed that Chipotle was different than their typical Mexican restaurant experience. And I'm encouraged and excited about the potential because of the strong customer loyalty we're starting to see. I think it is already showing that Chipotle's long term potential isn't just about burritos and tacos, but rather is about the possibility of serving great tasting food made with great quality ingredients prepared according to classic cooking methods and served in an interactive service format. We'll leverage our top performing field teams to open the 2nd and third shop houses that are under construction in Washington D. C. And Los Angeles, both of which are slated to open during the first half of this year. While all 4 of our growth seeds are currently considered new markets following our portfolio strategy, I'm most encouraged by Canada and Shophouse so far and feel that they're the 2 most likely to move on to proven market status in the near or medium term. France is still very new and it looks likely that London will be a developing market for a while until our awareness is raised there. We believe that all of these seeds that we have planted from international expansion in Toronto, Vancouver, London and Paris to Shophouse will all be successful. Even though we're unable to predict when a market will reach proven status, this strategy of planting a few high potential seeds and then investing more over time based on things like how well the team is performing and the quality of the food and the experience and the awareness and sales of the restaurants is a great way for us to ensure that we're developing growth options for the future while being responsible and thoughtful with how and where we're investing today. I'll now turn the call over to Monty. Thank you, Steve. We continue to make significant strides in the development of our people culture during the quarter and throughout the year. And as the year came to an end, we promoted 2 special leaders, both of whom have had tremendous impact on our culture and will help us accomplish even more in the coming years. Gretchen Selfridge, who previously served as Regional Director of our Rocky Mountain region and Mike Duffy, who is our RD for the Pacific region, are now both restaurant support officers. Both Gretchen and Mike started as general managers when we had just a handful of Chipotles, which is a great indication to all of our current crew and managers about what's possible at Chipotle. Through these promotions, all of our restaurants around the country are going to benefit from Gretchen and Mike's extraordinary leadership and ability develop restaurant tour cultures in their restaurant. Their track record in leading teams to develop restaurant tour cultures is unmatched at Chipotle. Gretchen began her career at Chipotle as a General Manager in 1996 and became a Regional Director in 2,001. Since the beginning of our restauranteur program, Gretchen's region has developed 129 restauranteurs. Her passion for getting to know her people and inspiring her team is a model for many future leaders at Chipotle. As an RD, Gretchen and her team oversaw hundreds of general managers, and I'm certain that Gretchen could tell you personal stories about each and every one of her managers. Mike also began working at Chipotle as a General Manager in 1996 and moved up quickly. In 2005, he took over a struggling Pacific region and under his leadership, it has become one of our most successful regions. Mike truly understands our Pacific excuse me, our people culture and has been very successful building our culture in the Pacific region, leading the company in restaurant tour development in both 2011 2012 and having among the strongest field leadership in the country. As restaurant support officers, all of our restaurants and field leadership teams will benefit from Gretchen and Mike's leadership, as they are 2 of our leaders who have been most involved in building our people culture. Now Gretchen, Mike and Jack Hartung will all join Steve and I interviewing restauranteur candidates so that we can keep pace with the heightened level of restauranteur development that we're seeing in our ranks. We believe the time is right for these terrific leaders to become more actively involved in the restauranteur sign off process given their demonstrated ability to identify these cultures and also lead them. The strength of our field leadership has allowed us to grow without having to add new layers simply by expanding the span of control of new and established leaders. Instead, we've been able to develop new leaders and expand the scope of their leadership to allow us to effectively manage our growth without complicating our structure with unnecessary layers. We continue to accelerate the development of managers to restaurant tours. In 2012, we promoted more than in any other year, finishing the year with 190 new restaurant tours, as well as 210 R plus promotions. Similarly, we are seeing a higher percentage of candidates being promoted to restaurant tour than ever before, more than 86%, which tells us that our field teams better understand what makes a restaurateur and the quality of our managers in our restaurants is getting better all the time. During the Q4 alone, we promoted 59 new restaurant tours out of 67 candidates interviewed, a selection rate of 88%. We also promoted 43 R pluses, 8 apprentice team leaders, 9 team leaders and 2 team directors, and one of our team directors has committed to open all 8 of his new restaurants this year at the restauranteur level. My hope is that I'll hear from other team directors that they have similar expectations for their new restaurants, as I'm finding that our new managers who are promoted from a restaurant to a restaurant don't know any other way to open a new restaurant than to open it with a team of top performing empowered teams who achieve high standards. In other words, a restaurant tour culture from the very first day. Are pleased that all of these metrics of internal promotion far exceed the pace from the Q4 2011 when we had 25 new restauranteurs promoted with a selection rate of only 66%. The strength of our people culture and the cultures we are building in individual restaurants is paying off for us in a number of ways. Our restaurants are running more efficiently and our unit economics are strengthening, but we're also providing better and better customer service and throughput. The reason for this is simple. Empowered top performers do a better job. Even though the 4th quarter is slower than the 2nd and third quarters, our emphasis on throughput continued. We were able to add an average of 3 transactions per peak hour compared to the Q4 of 2011. On Fridays, typically our busiest day of the week, transaction rates were up 1 transaction per 15 minute interval during peak hours. The number of transactions per day in our restaurants increased 3.4% over the Q4 of 2011 and for the full year they increased 5% over 2011. But it's important to us that the percentage of transactions during our peak hours that is to say between 12 and 1 lunchtime and between 6 and 7 for dinner outpaced the all day rates in 2012 demonstrating that our throughput ability during the busiest times is improving more than it would simply due to the increase in people coming through our doors. While comps decelerated a bit throughout the year, our managers and crews continue to pay attention to throughput, recognizing that better throughput provides a better customer experience that our customers really appreciate. As we head into our busiest month seasonally, we will continue to emphasize throughput with our managers and crews and believe that we will see additional improvements at that time as restaurant volumes increase. Turning to our real estate development plans, things are looking very strong. And we've been able to find great sites for new restaurants, which allowed us to open more restaurants in 2012 than the high end of the estimates that we provided for the year. Additionally, our new restaurants are opening at very favorable volumes, giving us tremendous returns on invested capital. With strong real estate performance in 2012 and a slight recovery in new construction, we are confident in the guidance that we have provided to open 165 to 180 new Chipotles this year, with about 40% of these restaurants opening new developments, up from 30% at the low in 2010. This year, nearly 20% of our new restaurants will be A Model locations, which you will recall are full functioning Chipolays, but with lower occupancy costs, lower operational costs, as well as lower development costs, making them very attractive locations for us. This part of our real estate strategy has helped us to find great locations while providing attractive returns given the lower costs associated with these sites. It gives us a great sense of optimism heading into 2013 that the culture in our restaurants is accelerating quickly enough to allow us to continue to grow its terrific restaurant operations and the type of dining experiences that will continue to create significant demand for new Chipotle restaurants. Looking over the 1st part of this year, I think it's entirely I'll now turn the call over to Jack Hartung. Thanks, Mani. We're extremely proud of the results that our restaurant teams delivered during the Q4 and for the entire year of 2012. And while achieving these strong results is quite an accomplishment, what's more important is that our food culture, our people culture and our business model all continue to get stronger. Sales in the Q4 increased 17.2 percent to $699,200,000 driven by new restaurant openings and a comp increase of 3.8%, which is driven mostly from increased traffic. For the year, sales increased 20.3 percent to $2,730,000,000 and the comp for the full year was 7.1%. Menu price increases mostly from an increase taken in 2011, up the full year comp by 2.8%. And our average restaurant now generates sales over $2,100,000 Our underlying comp transactions were also 3.8% in the quarter. Though we had 90 basis points of price in the 4th quarter related to the specific price increase from last March, that was offset by fewer drinks as more customers order their meal to go and by slightly smaller group size as our larger online and fax orders were down slightly from the previous year. We'll face harder comparisons in the Q1 as we will lose 2 days or about 200 basis points of comp due to leap day and Easter. And in addition, we're comparing to mild winter weather in the Q4 of last year when we benefited by an estimated 100 basis points to 200 basis points. Our new restaurants continue to perform well, opening with sales at or above the high end of our communicated range of $1,500,000 to $1,600,000 We opened 60 new restaurants in the quarter, bringing our year to date openings to 183, which exceeded the high end of our guidance range for 2012, ending the year with 14 10 restaurants. As we mentioned during our last earnings call, we plan to open between 165 and 180 new restaurants in 2013, and we expect these openings will occur relatively evenly throughout the year. Diluted earnings per share for the quarter was $1.95 an increase of 7.7 percent. Restaurant level margins decreased in the quarter by 150 basis points to 24.6 percent as food costs increased by 130 basis points over Q4 of 2011. EPS was $8.75 for the full year of 2012, an increase of 29.4% from 2011. Efficiencies from higher comps allowed us to leverage nearly every line item on the restaurant P and L except for food, which for full year 2012 was up 10 basis points compared to 2011. Restaurant level margins for the full year were 27.1 percent, an increase of 110 basis points. Food costs were 33.5% the 4th quarter, up 130 basis points from 2011 and sequentially higher by 90 basis points from the 3rd quarter. This represents higher than expected inflation of 2.8% over Q3 and about 5% over Q4 of 2011. Inflation was driven by higher beef and cheese costs as well as slightly higher costs for our salsa. While food costs increased faster than expected in the 4th quarter, they leveled off a bit in December, so we're optimistic that food inflation will be relatively modest over the next few quarters or so. And overall, we expect our food costs in 2013 will be in the 33.5 percent to the 34% range before the impact of any menu price increase. While we've made no decision on a menu price increase for this year, the inflation we have seen so far makes it more likely that price increase may be warranted, but we'll monitor trends such as additional inflation going forward, our comp trends, general economic and consumer confidence trends, and based on these factors, we'll make a menu price decision later this year. Labor costs were 23.9 percent of sales in the quarter, an increase of 10 basis points from 2011. Labor deleveraged slightly as wage inflation, including promotional increases, more than offset any leverage from the comp. For the full year, labor costs were down 40 basis points from 20 11 due to leverage from the higher comp of 7.1%. Other operating costs were 11.5% in the quarter, which was flat compared to 2011, but that was up 100 basis points sequentially from Q3. Higher marketing and promotional activity in the quarter accounted for most of the sequential increase. For the full year, other operating costs were 10.5 percent or down 60 basis points compared to 2011 on favorable sales leverage. Marketing was 1.8% in the quarter compared to 1.6% in the Q4 of 2011. We invested more in marketing during the quarter, which included our Cultivate event in Denver, as well as some new content programs we're working on, which Steve mentioned. While marketing was just 1.3 percent of sales in 2012, we expect it will be closer to our historical rate of about 1.7% of sales in 2013. G and A was 6.2% in the quarter, 20 basis points lower than 2011 due to favorable sales leverage. And for the full year, G and A was 6.7% or 10 basis points higher than 2011. The non cash non economic stock comp expense was $66,000,000 for the full year, of which $64,000,000 was included in G and A. Stock comp expense for the Q4 included in G and A was about $12,000,000 And this is $3,000,000 higher in the quarter and $22,400,000 higher for the year compared to 2011. And this was as a result of stock options issued at a much higher stock price, which resulted in a much higher calculated accounting charge. For the year, our underlying cash G and A, adjusting for the higher non cash stock comp expense, is lower as a percentage of sales as a result of our continuing effort to grow our underlying cash G and A at a slower rate than our sales growth. In 2013, we expect G and A as a percent of sales to be about the same or perhaps slightly less than in 2012 as the benefit from not having the expense from our all manager meeting will be offset by higher non cash stock comp expense. Based on today's stock price, total non cash stock comp expense for 2013 is estimated to be in the range of $72,000,000 to $77,000,000 assuming a similar number of options are granted. Our 2012 effective tax rate was 39.3 percent and this is 80 basis points higher than in 2011, primarily as a result of the Higher Act expiring and several credits not reflected in our 2012 tax rate, including the work opportunity tax credit and the R and D tax credit. These credits were renewed by Washington for 20122013, but they were not approved until January 2013, which prevents us from adjusting our accounting tax rate in 2012. As a result of these credits being approved, we estimate our annual tax rate for 2013 will be about 38.5 percent, with the 1st quarter tax rate being lower by approximately 100 basis points to 150 basis points when we recognize those 2012 tax credits in our Q1 tax rate. Each of the remaining 3 quarters will have a higher tax rate with the overall rate for next year estimated to be about 38.5%. We were opportunistic with our share buybacks in 2012 and have invested about $229,000,000 buying back our stock since January 1, 2012 up until today. During the 1st 6 months of 2012, we repurchased about 74,000 shares for about $29,000,000 and then from July 1 until today, we invested another $200,000,000 to repurchase about 683,000 shares. We still have about $80,000,000 remaining on our current $100,000,000 authorized share buyback and our Board has already approved an additional $100,000,000 Over the past 4 years, we've invested over $520,000,000 to repurchase our stock at an average share price of $135 In 2012, our average development costs in the U. S. Were about $800,000 and capital expenditures totaled about $187,000,000 in 2012 and that's net of landlord credits of about $10,000,000 primarily related to new restaurants along with continued reinvestment in existing restaurants along with other company initiatives. In 2013, we anticipate CapEx will be around $200,000,000 again net of landlord credits, the majority of which relates to new restaurant construction. In addition to our normal reinvestment for existing restaurants, we'll invest in initiatives such as converting our restaurant lighting to LED, completing a few major remodels from our old design in New York to our current design, and we plan to upgrade the planche's or our grills in many of our restaurants this year. We were able to increase our total cash and investments by $79,000,000 during the year, even after funding the opening of 100 183 new restaurants and repurchasing stock to our share buyback agreements totaling over $200,000,000 We continue to believe that investing in our high returning restaurant remains the best use of our cash and we're confident that the growth options we're seeding today, including Shophouse and Chipotle in London, Toronto, Paris, Vancouver and beyond, will provide value enhancing growth opportunities in the future. In the meantime, we'll continue to invest in our high returning domestic restaurants and we'll opportunistically repurchase our stock to enhance shareholder value. So thanks for your time today. At this time, we'd be happy to answer any questions you may have. Operator, please open the lines. And we will take our first question from Joe Buckley from Bank of America Merrill Lynch. Thank you. Could you run through the year over year changes in marketing? I got revenues expectation, but just a number of markets where you'll be active this year versus last year. And how are you defining moving towards more transaction driven or traffic driving marketing? Yes. Joe, I'll clarify in terms of the marketing spend. I think you caught that. We do plan to spend more historically, we've spent about 1.7%. But the last couple of years, as we've been trying different marketing initiatives, we've underspent that amount. Last year, we spent about 1.3%. Next year, we do expect to get closer to that 1 point 7%. But then your other question was about which markets we plan to focus on and where we intend to invest our marketing dollars. Is that the follow-up to the other question? Yes. Just if you want to talk about where, that'd be great. But just in terms of the percentage of the store base that will be covered by more active marketing programs and how you're defining that? Yes, Joe. I think the best way to answer this without getting into a very, very detailed discussion is, we cover all of our restaurants, 100 percent of our restaurants. But in larger markets where we've got a lot of restaurants and where it's efficient to buy media, we'll do the full complement of media, which we're going to do some of that, as Steve mentioned in March and I think he said 25 of our markets. And in those markets, we're going to invest in billboards and if it's efficient, we'll do radio, we'll do some print as well. We can't do that in some of our smaller markets or where it's very expensive to buy the media. So in those markets, we'll do local store marketing. For sure, we might do we also will invest in social media as well. And so each of our markets have a unique marketing strategy, depending on how many restaurants we've got, how efficient it is to buy the media. And based on the needs, how well our brand is recognized, how loyal the customers are. And so our marketing plan is going to be customized market by market. And how does that 25 markets where you do the full complement of media compared to what you did in 2012? It's more. I mean, I don't know offhand. We had done a number of markets this past year, but we're going to be doing more of that kind of marketing in 2013. Okay. And And so that's how it explains, that's where part of our additional investment from 1.3% to 1.7% is going to be to providing more coverage of that kind of billboards and radio and the like in more of our markets in 2013. Okay. And the call to action, how are you kind of defining that? So what can you say it again, John? Well, you've indicated that you're going to get more traffic focused with the marketing. I'm just curious how you define that versus what you've done historically? So I think a lot of that has to do with the creative, Joe. I mean, in years past, a lot of our marketing or I should say most of our marketing was what we call brand building market, which brand building marketing, which spoke to food with integrity, the quality of the restaurant experience, the way we're different, things like that. Mark and his team have made a concerted effort to actually create devices, for instance, in the new short films and shows that are currently under production, the ones that were similar to Back to the Start, have components which will can direct people online to get engaged and to take opportunities of going in for some kind of a promotion, a buy one get one, something like this. Where in the past, we sort of left that opportunity on the table with back to the start where there wasn't a transaction driving component. So I think you're going to see more things like that that actually push people into the restaurants rather than just talk about brand building in general. Okay. That's helpful. Thank you. Thanks, Joe. And we'll take our next question from David Palmer with UBS. Hey, guys. With regard to the marketing, is that something that you would use in particular to support catering, for example? Yes. Catering marketing is going on in Denver as we speak. And certainly that is very much directed at getting people to go into the restaurants and try it. It specifically talks about how it works, come in and try it, how what you can expect the experience to be. So yes, that's definitely marketing that's getting people to actually go in and place their catering order or place it online. I guess, I just I'm sorry, I was if I interrupt there, but I was just thinking about the in the marketing and the brand awareness, there is often a phenomenon where certain chains get up to a certain scale in an individual market and the fact that they get up to that scale in and of itself and that brand awareness just by the number of locations helps the comps. Are you finding that you get up to a certain amount and just adding that extra layer of marketing and whether it be billboard and keep that above average market awareness curve going in the right direction? Is that essentially what you're doing here in certain developed markets? It's certainly not the main intent of this marketing catering. The main intent is to introduce people to catering. I think because it's so heavily marketed and because this is really new news in a very well developed market, I think you're going to have the effect of just helping to bring renewed awareness to Chipotle in general. And our hopes would be that, yes, that would help drive traffic. I think that will be an offshoot of that. Thank you. Good luck. Thanks, David. And we will take our next question from Andy Barish with Jefferies. Hey, guys. Question on just the comp direction so far year to date. I mean, the way should we look at it as if we take the 4th quarter trends and sort of take out the 2 point trading day shift? Is that kind of the way you guys are thinking about the start of the year? I wouldn't do it that way, Andy. Here's why. We started a trend. I like to look back to 2,009 as kind of our baseline year. That was during the year of the depth of the recession. And during that year, we had 4 quarters of 2% comp. We started our sales increase. We started our recovery from the recession in the Q1 of 2010 and then built sales in the Q2 and Q3. And so they are higher in Q2 of 2010 and higher in Q3 and higher in Q4. And then the next year, we did a double digit comp. And then we continued double digit comp for, I think, it was 7 quarters. And so we've had this kind of stair step building quarter by quarter by quarter for 12 quarters over the last 3 years. And now we're starting 2013, comparing against all three of those years. So we have some very, very tough comparisons. So I wouldn't look at the 3.8% that we did in the Q4 and say that's our starting point. I would look at it as we're comparing now against 3 years' worth of comp in the Q1. And it's a total it's almost 30%. We're up almost 30% in the last 3 years. When you look back over the 4 quarters and you look at a 3 year comparison since we recovered from the recession, this quarter is going to be our toughest comparison of all. And it's the toughest for the reasons I mentioned in my prepared comments, where we had extraordinary mild winter weather last year. And so we had a very high comp on top of a very high comp from the year before. We benefited from an extra day last year. And in addition to those 2 tougher comparisons, we're losing a day this year with Easter. So I'm not quite sure how to tell you what the Q1 how it will turn out, to be honest. But I wouldn't start with a 3.8%. I think it's going to be a tougher hill decline than starting with 3.8%. Percent. Okay. And then thanks. And then one quick clarification just on the food costs. So again, the starting point of sort of the 4th quarter, the 33.5%, am I correct in saying that food costs will kind of run-in that 33.5% to 34% until we see your next pricing action? Well, yes, that's exactly right. That's what our hope is. The inflation that we expected hit us harder and faster than we thought it would in the Q4. But now as we look ahead, it looks like we'll stay in kind of the range you mentioned 33.5 to 34. I mean, it looks like it's going to stay in that range for a few quarters. So we don't have any specific plans to do an annual price increase. I wouldn't expect that we'll even consider doing something in the first half of the year. So I think the earliest we might do something would be mid year. But as long as inflation stays in that range, we'll get through the next few quarters and then we'll look at what the outlook for inflation in the second half of the year, what the economy looks like and what our transaction trends look like and then we'll make a price decision at that time. And just finally real quick, what was the salsa issue that hit you guys in the Q4? Well, we had 2 things. 1, we bought more of our white corn. We've been moving away from the yellow corn into white corn. And so there's a little bit of a premium, not a big amount, but that contributed to it. And then we actually had to source some of our tomato salsa from the West Coast during the quarter just because we are having trouble keeping up with supply for some of our East Coast restaurants and so we had to pay a premium just to get some of the tomato salsa from the West Coast into the East Coast. So more of was more temporary. The white corn is going to be more of an ongoing premium that we'll pay to continue to source white corn. Thank you. Thanks, Andy. And we will take our next question from Michael Kelser with Goldman Sachs. Hi, guys. Hi, Michael. I guess on that so the food cost question, I mean, at 33.5% of sales, it's the highest it's been in any quarter in recent history. And the guidance 33 to 0.5% to 34% is in line to higher than that. Why are you letting yourselves get behind on pricing? Like what's the reticence to keep up with inflation? And especially in light of previous comments you guys have made about your belief that the elasticity for the Chipotle brand is limited. Why wait? Because Michael, the most important thing to us right now is to build customer loyalty and to build transaction momentum. The thing we'd rather not do as we saw our transactions level off last year, and we're happy with a 3.8% transaction growth. But that's one of the lowest transaction growths that we've seen over the last 3 years. And so what we don't want to do is during a time when the economy seems to be okay, but not great and it's not clear what's going to happen as we hit this next the debt ceiling crisis and how people are feeling with their payroll tax increasing. We'd rather be more patient. We'd rather see what happens with the economy, what happens with our transaction trends. And if we're a little late to the game in raising prices, that's okay, because as soon as you raise prices, the margin for our model bounce right back to where they can and should be on a going forward basis. So the headline is, we don't want to risk interrupting transaction or causing transactions to soften during a time like this. That's why we'd rather be more patient. Very helpful. And then the other thing was on labor costs, which I was looking they're roughly flat as a percentage of sales over the second half of twenty twelve. So I guess if same store sales stay in their current range and now the Affordable Care Act flows through within about a year or so, might labor costs start to delever from here unless comps meaningfully reaccelerate? Yes, we need without considering any increase in health care costs, we've always talked about we need kind of a mid single digit transaction driven comp in order to just hold on to our labor line. And you saw that play out during the quarter where we had a slight increase in basis points, let's call that basically flat with a 3.8% comp. If we had a slightly higher comp, maybe 4.5%, it probably would have been exactly flat. And that's consistent with what we've said really over the years that we need kind of a mid single digit comp. But the reason for that is when it's transaction driven, we need to add labor hours. We actually have a labor chart that has a prescribed number of hours to add as we add additional transactions. Lever labor. To the extent that we have additional costs with healthcare next year, that will cause our labor costs to go up. Now we think that the 1st year, Michael, it won't be that big increase, we think 2014, because the penalty for employees not opting. Our plan right now is to offer insurance to qualified hourly employees. But the penalty for not electing for employees not electing insurance is so low and the cost of them electing insurance, their cost is so high. We think it's likely that most people won't elect it. So we think our cost in 2014 is not likely to be that extreme. We think that those costs are likely to hit us more so in 2015 2016 as that penalty begins to increase. Thank you very much. Thanks, Michael. And we will take our next question from Paul Wustrow with Cowen and Company. Hi, good afternoon. Hey, Paul. Good question, Paul. Pardon me, how are you? Just on your CapEx budget, can you give us a little bit more detail? I know you outlined a little bit extra spending here, but obviously CapEx looks to be up about $13,000,000 in the year, yet you might have even less openings and kind of back into what maybe incremental cost is for the grills. Can you give us maybe more color of how many remodels you'll be doing? And on the grills, what impact they might have on expenses? Do you have a payback for the new grills? Or is that a quality investment? Yes, we've got Paul. I mean, we're planning on a similar number of openings. It's in the same kind of ballpark. But yes, we're going to spend an extra about $13,000,000 The grills are going to be depending on how many we replace a few $1,000,000 could be in that $3,000,000 $4,000,000 $5,000,000 kind of range. There is an extremely favorable payback. These new grills not only produce better tasting food, they're easier to maintain, but the utility usage on these new grills is dramatically improved such that we can get a payback within a matter of a few years. And so those make a ton of sense. Same thing with the LED lights, that will cost us a few $1,000,000 as well. We have no choice because we have to get rid of the old bulbs and we have to move towards LED. The old bulbs just won't be available. They stopped manufacturing them. And those will have a payback as short as the grills, maybe even shorter. It could be that we had to pay back on those as short as 1 year. And so these investments make a lot of sense for a lot of reasons. And then we're going to do a few remodels. These are a handful in New York where these are some older restaurants where we went into a very old building, very tough from a construction standpoint. And the building is not holding up that well and it's our old look. And so we're going to invest in remodeling those restaurants. I would not expect us to be doing a bunch of major remodels every single year. That's a matter of a few $1,000,000 that we're going to invest in upgrading a handful of restaurants in New York. And then how many stores have the new Grill as of now? Oh, God, I think it's a handful right now. Yes, yes, it's a handful. I mean, Steve and his call and our team have been working with this grill for quite some time now. And I mean, it's better in every single way and we've been anxious to get the new grill and as many restaurants as possible. And we think 2013, we're going to be able to make a big dent in that. You can cover most of the base in a matter of a couple of years rolling out Yes, within a couple of years, yes, we think we can. Okay. Thank you. All right. Thanks, Paul. And we will take our next question from Jeffrey Bernstein with Barclays. Great. Thank you very much. Two questions, I guess. First just following on the earlier topic of pricing. I know you talked about at the earliest maybe mid year. But I'm just wondering theoretically how you think about it. I know in the past you did, well it seems like these pricing going forward will be more nationwide rather than in one specific market with the rollout of let's say premium ingredients. I'm just wondering how you think about it whether I thought in the past you've talked about you'd prefer to do one larger increase rather than smaller increases. So I'm just wondering with the current inflation level what pricing would you consider? And are there any concerns when there's only a few well recognized items on the menu in terms of how you take that price? Yes. Let me take a crack at it. There's a lot to that. But let me try to in a condensed answer try to cover all those, Jeff. In terms of the percentage increase, if we're talking about inflation in that kind of mid single digit range, 3%, 4%, 5%, a price increase would in that same kind of 3%, 4%, 5% range, if you exactly match the food inflation, that would allow our food cost to bounce right back to where it was before this inflation. It would allow all of our other line items to get better, okay? And so it wouldn't take much of an increase to get our food cost right where it backwards should be and get our margins back to where it was before the inflation or maybe even better. And as a perspective, a 4% or 5% increase on a burrito is about $0.25 or $0.30 So it's not that much. If you compare that, I know some have assets will instead of doing one price increase in a year or one every other year, why don't you do a few small ones? Well, if you're only going to do a 4 or 5 ish, let's say 4 for a sec, for example. Instead of doing 4, you could do increases and you do 2% at a time. But now what you're talking about doing is an increase of an Aburrito of maybe $0.10 or $0.15 dollars early in the year and then do another $0.10 or $0.15 later in the year. And we'd rather not kind of nickel and dime our customers. We'd rather kind of do it one time. We'd rather have the conversation them one time, because a lot of customers don't necessarily notice the amount of the increase, but they do notice when you're increasing it multiple times. And so our real desire is to not increase prices. We'd rather find efficiencies ourselves. And that's why we've always been patient. We'd always try to make sure that we can find as many efficiencies within our existing business model before having to raise prices. But in cases like this where we think we're finding most of the efficiencies or have most efficiencies in our model, where inflation has put our food costs up into this range, 33.5%, 34% or so, we find that we have no choice but to raise prices. So does that help, Jeff? Does that answer your questions? Yes. So the 4% to 5% wouldn't be unreasonable. You kind of look at it as I'd rather raise a quarter one time rather than mobile? I think 2 things that's in our thinking. Yes, we'd rather not do what we did 3 or 4 years ago where we waited 3 years or more in certain in a lot of our markets and then we raised prices 7%, 8%, 9%, okay? That we want to avoid at all costs, but when you're talking about a quarter or so, we think that's not an unfair increase to take. Got it. And then just separately on the new unit productivity, I know there was some noise in the middle of 2012 with your new unit openings. I'm just wondering if as you look out to 2013 as it relates to kind of this productivity, I think you said it was 40% in new developments and 20% A sites. But putting that all together with that as a mix, what would be your expectation for productivity? What would have maybe the most or least impact? I mean, just so we're prepared for thoughts on new unit productivity based on what you know today in terms of your unit openings? Well, our new unit productivity has increased sort of steadily over the years as our comp sales have increased. Our new units have kind of followed suit and been a substantial percentage of the amount of those of our average unit volumes. So when you talk about a stir in the middle of 2012 with regard to new unit productivity, from our standpoint, there wasn't any stir. What you're probably referring to is that there was some talk about like new unit productivity falling off in 2012. From our perspective, that's really not what happened. What did happen was that we had a pretty exemplary 2011 with very high new store opening volumes driven in large measure by the fact that we were opening a great deal of our restaurants in proven markets and these proven markets have, as Steve mentioned in his opening words, a very high likelihood of delivering great returns. And so we opened a lot of in 2010 and 2011, we opened a lot of our restaurants in these proven markets. Our A models in 2010 2011 were almost all in proven markets at that point. And that was very intentionally done by us to basically stack the deck in our favor of our A Model strategy being successful and it worked much, much better even than we thought it might with new unit volumes for our A models that were literally just about at pace for our traditional openings. But with the lower cost structures associated with those A models that meant that our returns on the A models were extraordinary. In fact, during those years much better than our traditional openings. So when we went into 2012 before that year began, we explained to you guys that we would be continuing on with our A Model strategy, but doing it in taking some more risk with it and going into developing markets and experimenting with the A Model strategy in those developing markets. We did so. It's been very successful. The A models now are still are opening nearly at that new store opening rates lower than the traditional models now in terms of openings, but with returns that are really at pace very, very similar to the returns of our traditional units. So we feel very, very strongly about new unit productivity. We felt that it's been an uninterrupted store productivity over the years with the possible exception that 2011 was an outlier to the good and an extraordinary year due to having so many in proven markets and having so many A models in proven markets and taking a little bit more risk thereafter. Got it. So 13 is more normalized based on the lap of 12 versus the anomaly of perhaps 10 and 11? Yes. I think that's a fair estimate. We'll see how it goes. But we feel very, very good about the way they're opening and don't see any reason why we wouldn't continue to have the success with our new stores that we've come to rely upon. Very helpful. Thank you. You bet. And we will take our next question from David Tarantino with Robert W. Baird. Hi, good afternoon. Jack, just a quick clarification question on the trends in the Q1. Perhaps maybe if you could talk about what you've seen so far and if you've seen any change in the momentum of the business and if you feel comfortable giving some directionality on the comps that would be great? Yes, David. I usually do give some kind of indication based on how sales are doing. I'm really unable to do it this time. And the reason is because there's not really a pattern that I could see in January that I could tell you would give you an idea of what's going on in the rest of the quarter. The reason for that is we had some days and some weeks that were really nice mild winter weather and our comps looked better than expected. And then we've had some snow and cold and some normal winter weather. And then the comps fell off quite a bit as you would expect. So I've not been able to really pick up a pattern, but I could tell you what I expect during the quarter. So the only thing I can tell you at this point is the quarter is a tough comparison for the reasons I mentioned, because we're comparing to the 3 year nearly 30% and we're missing a couple of days and we're comparing to and we're just now comparing, by the way, to some of the really mild weather. Most of the mild weather we saw last year was in February. So the Q1 trend, Dave, still to be rewritten. And so I'm sorry, but there's nothing I can tell you to give you insight in terms of how the quarter might finish. Okay, fair enough. And then Steve, a big picture question on the Chipotle brand. It seems like you're talking a lot more about traffic drivers in terms of advertising and catering and a new menu item. And I'm just wondering if you think the brand is reaching a point at which you need those traffic drivers to continue to sustain the unit volumes that you're seeing currently? I don't know if need is the right word. Over the years, we've had a lot of requests and we've ignored a lot of those requests for fear that it might upset the focus that we have, which contributes to a great economic model, as you know. But a couple of things appear to be sort of really important requests we think and that has been the ability to enjoy Chipotle in people's school or office or some other large venue kind of area. And that's why we think catering is a really good option for that. People did these catering events, but we would make boxes and boxes of burritos and we feel that this is a completely different experience that and that we thought that people would enjoy and they are enjoying it and it's really a new way to experience the same stuff and it's very, very efficient for us to do. The other item that the Sofritos, we think is really, really important because it speaks to not only a new taste and new experience in Chipotle, but it speaks to this idea of food with integrity that even if one is not a vegetarian or a vegan, you can participate in this idea that eating less meat is somehow environmentally responsible or maybe better for your health. A lot of people think that eating less meat is more helpful. So we've created this exciting new thing called Sofritos, which really has I mean, it's very, very savory. It has this umami flavor, this the 5th flavor, which is something that a lot of vegetarian offerings don't have. Vegetarian offerings at a lot of restaurants seem to be the dish, but without meat. This is something that's very deliberate in creating something that's vegan and quite delicious. So these are things that we've been thinking about for a long time, mainly by listening to our customers and deciding if it actually fits into the economic model or doesn't degrade the economic model. And in fact, I think catering has the potential to dramatically improve it, because we can serve these 200 to 200 people much more efficiently, much more quickly than if they were to come through the service line. And the SOPRITOS is quite easy to prepare. It's braised and has lots of ingredients, but the actual preparation, the finishing preparation in the restaurants quite efficient. And it only takes up one of our service containers on the line. So I think both of these are going to help people enjoy Chipotle more often and perhaps in different ways without a degradation to the model. So hard to really answer your question whether we need this, but it seems like the time is right and it's fun to try new things in a very sort of measured way. That's helpful. Thank you. That concludes today's question and answer session. At this time, I'd like to turn it back over to the speakers for any additional or remarks. Thanks for joining us everyone and we look forward to speaking with you next quarter. Ladies and gentlemen, this concludes today's conference. We thank you for your participation.