Chipotle - Q4 2022

Transcript

Operator (participant)

Good day, welcome to the Chipotle Mexican Grill Q4 2022 results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Cindy Olsen, Head of Investor Relations and Strategy. Please go ahead.

Cindy Olsen (Head of Investor Relations and Strategy)

Hello, everyone, welcome to our Q4 fiscal 2022 earnings call. By now, you should have access to our earnings press release. If not, it may be found on our investor relations website at ir.chipotle.com. I will begin by reminding you that certain statements and projections made in this presentation about our future business and financial results constitute forward-looking statements. These are based on management's current business and market expectations, our actual results could differ materially from those projected in the forward-looking statements. Please re-see the risk factors contained in our annual report on Form 10-K and in our Form 10-Qs for a discussion of risks that may cause our actual results to vary from these forward-looking statements. Our discussion today will include non-GAAP financial measures.

A reconciliation to GAAP measures can be found via the link included on the presentation page within the investor relations section of our website. We will start today's call with prepared remarks from Brian Niccol, Chairman and Chief Executive Officer, and Jack Hartung, Chief Financial and Administrative Officer, after which we will take your questions. Our entire executive leadership team is available during the Q&A session. With that, I will turn the call over to Brian.

Brian Niccol (Chairman and CEO)

Thanks, Cindy. Good afternoon, everyone. We delivered another year of strong results in 2022, expanding AUVs and restaurant level margin despite facing one of the highest inflationary periods on record and an uncertain macro environment. These results demonstrate Chipotle's resiliency, driven by our talented teams, delicious food made fresh daily, convenience, customization, and of course, our tremendous value. For the year, sales grew 14% to reach $8.6 billion, driven by an 8% comp. Digital sales represented 39% of sales. Restaurant level margin was 23.9%, an increase of 130 basis points year-over-year. Adjusted diluted EPS was $32.78, representing 29% growth over last year. We opened 236 new restaurants, including 202 Chipotlanes.

Turning to the Q4, while we were pleased with our overall growth, our results were impacted by a few factors that were unique to the quarter, including a lower-than-expected benefit from Garlic Guajillo Steak and a headwind from loyalty accounting. For the quarter, sales grew 11% to $2.2 billion, driven by a 5.6% comp. In-store sales grew by 18% over last year. Digital sales continued to represent 37% of sales. Restaurant level margin was 24%, an increase of 380 basis points year-over-year. Adjusted diluted EPS was $8.29, representing 49% growth over last year. We opened 100 new restaurants, including 90 Chipotlanes.

Our transaction trends improved throughout the quarter as we lapped brisket, and I'm pleased to report that our underlying trends have further improved entering 2023, with transaction trends turning positive. For the Q1, we anticipate comps in the high single-digit range. Our focus on getting back to the basics and running great restaurants is beginning to pay off, and we plan to further emphasize this in 2023. Additionally, we will continue to build upon our five key strategies that will help us to win today while we create the future. Now, let me provide an update on each of these strategies, which include, Number one, running successful restaurants with a people accountable culture that provides great food with integrity while delivering exceptional in-restaurant and digital experiences. Number two, sustaining world-class people leadership by developing and retaining diverse talent at every level.

Number three, amplifying technology and innovation to drive growth and productivity at our restaurants and support centers. Number four, making the brand visible, relevant and loved to improve overall guest engagement. Number five, expanding access and convenience by accelerating new restaurant openings. Beginning with our restaurants, as we discussed on the last call, Chipotle is a restaurant business with high standards, and it is critical that we treasure the guest and deliver an exceptional experience, including great culinary and in-restaurant execution. During the pandemic, there were unforeseen challenges such as supply outages, staffing challenges, and exclusions from COVID that resulted in a need to create workarounds. We have been eliminating the workarounds and reestablishing operational standards with Project Square One, while continuing to build a culture of excellence in every aspect of our business.

This means ensuring all ingredients are in stock, that our teams are fully staffed and properly deployed during peak periods to drive throughput, that our delicious food is prepped and cooked on time, that we are improving throughput on the front line and improving on time and accuracy on the digital make line. Of course, that we are delivering exceptional customer hospitality. Project Square One has helped to lay the foundations, including training in each of these areas. We are also bringing back more shoulder-to-shoulder training. One thing that I believe everyone has learned from the pandemic is that virtual training is not the only tool needed. We are reducing the amount of virtual training and bringing new crew members into our restaurant sooner for on-the-job training. This helps to accelerate onboarding and gives more confidence to our new crew members as they are learning by doing.

Shoulder-to-shoulder training by experienced managers is an essential process. I'm also happy to see an improvement in turnover, with December being one of our best months in the past two years for both hourly and salary turnover rates. Our staffing levels continue to improve with 90% of our restaurants fully staffed. This, combined with better stability, leads to more experienced teams. When you combine this with Project Square One training for the past two quarters, positive signs are emerging across the operation. We are focused on operational excellence and have intensity and collaboration to achieve it. Great people and great culinary drives performance. Speaking of great people, I'm proud to share that in 2022, we promoted over 22,000 people, surpassing 2021, and 90% of all restaurant management roles were internal promotions. We have tremendous growth ahead.

In 2023, to open our new restaurants, we'll have the opportunity to promote over 1,800 hourly manager roles, over 255 GMs, and over 40 field leadership positions. These numbers will continue to grow as we expand our restaurants by our targeted range of 8%-10% per year. As we have said in the past, our goal is to be the employer of choice. In addition to career advancement opportunities, industry-leading benefits and competitive wages, we will continue to look for ways to improve the overall experience for our teams. We know one way is to continue to invest in technology and innovation. There are a couple of new stage gate initiatives that I'm excited to share, along with an update on improvements to our app functionality.

First, we are currently testing a new grill to improve the overall cooking process for our chicken and steak. The grill is much faster and has consistent execution, which lowers the learning curve significantly. Importantly, we believe it maintains our high culinary standards and can cook the chicken and steak to perfection. We look forward to further validating it through our stage gate process. Second, you may remember that in the Q2, we announced Hyphen as one of our first investments in our Cultivate Next fund. Hyphen is a food service platform that automates the assembly of meals on the digital make line and could help fulfill our promise to deliver on time, accurate orders for our digital guests. This would allow our restaurant teams to focus more on our in-restaurant guests on the front line, further improving throughput.

I'm thrilled to share that together with Hyphen, we are developing our first automated digital make line prototype, which we will test and learn on. We expect to have it in our Cultivate Center in the first half of this year. Speaking of our digital business, it is over $3 billion in revenue and represents 39% of our sales. We're constantly looking for ways to improve the experience for our guests. Last quarter, we started testing advanced location-based technology to enhance our app functionality. For guests who opt in, the program can engage with Chipotle app users upon arrival to our restaurants and utilize real-time data to enhance their experience with order readiness messaging, wrong pickup location detection, reminders to scan the Chipotle Rewards QR code at checkout, and more.

The results from the stage gate process were very encouraging, including an improvement in delivery speed, a reduction in customers going to the wrong location, and an improvement in the experience for our Rewards guests, allowing them to quickly scan for their Rewards points without impacting throughput. As a result, we rolled it out nationwide last month. Moving on to making our brand more visible, more relevant, and more loved, our Real Food for Real Athletes platform has been a success as we partner with athletes of all levels who are fans of Chipotle and focus on helping them perform their best by providing proper nutrition through real food and real ingredients. During the Q4, we teamed up with U.S. Men's National Soccer Team stars, Christian Pulisic and Weston McKennie, to showcase their journey to soccer's biggest international tournament while featuring the athletes go-to orders in our app.

We also continue to leverage social media to remain relevant with our consumers, especially Gen Z. This year, we surpassed two million TikTok followers, which to put into context, rivals some of the largest brands in the world, and we were the first brand to launch on the new social media platform, BeReal. Shifting to menu innovation. As we mentioned last quarter, 2023 will consist of one to two LTOs. I'm delighted to share that Chicken al Pastor has been validated and ready to be rolled out in the near future. This new menu item is operationally simple to execute while still providing a new exciting flavor that drives transactions and sales. We also recently launched a new lineup of Lifestyle Bowls that cater to contemporary wellness habits of Gen Z and millennials.

The lineup spans a wide range of healthy habits, such as our Balanced Macros Bowl, our High Protein Bowl, and our Grain Freedom Bowl. Lifestyle Bowls are a great way to show our customers that they can create balanced meals made with our existing ingredients that taste great and that they feel great eating. Turning to our Rewards program. In 2022, we increased our Rewards members by 20% to 31.6 million. Our program continues to get more sophisticated as we better understand who our members are and serve them with relevant content, targeted offers, and gamified badging to help drive transactions. In 2022, 60% of our Rewards program promotions were personalized, and we plan to increase this going forward.

To drive engagement and enroll new members, we recently introduced Freepotle, which offers each rewards member 10 personalized free rewards throughout the year. Our development team has done an outstanding job of navigating headwinds such as material shortages and permitting and inspection delays while successfully opening 236 new restaurants in 2022, including 202 Chipotlanes. In fact, we opened 100 new restaurants in the Q4, which was a record for the company. We also opened our 500th Chipotlane during the quarter as we expanded access and convenience through our unique digital drive-through format. The performance of Chipotlanes continues to be strong. In fact, since we began opening Chipotlanes in 2018, our new restaurant productivity has improved by about 1,000 basis points.

We plan to open 255 to 285 new restaurants in 2023, with over 80% including a Chipotlane. Within our 2023 expansion plans, we will accelerate new restaurant growth in Canada and continue to open restaurants at a measured pace in Europe. In Canada, we have built out a strong local field leadership team that works closely with our U.S. team to ensure best practices and a consistent culture while adapting to local needs. We are now ready for accelerated growth and plan to add around 10 new restaurants in 2023, which will be the fastest development growth rate since we entered the Canadian market. We also remain encouraged by the performance in Europe, despite a challenging macroeconomic backdrop.

In 2023, we plan to add a few additional locations in the U.K. We are also rolling out our digital capabilities to further expand access. We remain optimistic about the growth opportunity. We'll continue to update on Europe's progress through the stage gate process along the way. In closing, I want to thank our restaurant and support center teams for another terrific year. Our focus on getting back to the basics is starting to pay off. Our teams are energized. I'm excited to see further progress over the coming quarters. We have a long growth runway ahead, with the ability to more than double our restaurant count, grow AUVs beyond $3 million, and expand margins. I believe we have the right team and strategy in place. We will remain focused on meeting the standards of excellence that make Chipotle.

With that, I will turn it over to Jack.

Jack Hartung (Chief Financial and Administrative Officer)

Thanks, Brian, and good afternoon, everyone. Sales in the Q4 grew 11% year-over-year to reach $2.2 billion. Comp sales grew 5.6%, which included about an 80 basis point headwind related to our loyalty program. In Q4 of each year, we reevaluate the estimated loyalty breakage for points that will expire, and this year we decreased our estimate due to higher member engagement. Restaurant level margin of 24% increased about 380 basis points compared to last year. In addition to loyalty program headwind, restaurant level margin was impacted by a higher level of sick pay and medical claims in the quarter compared to our expectations. Earnings per share, adjusted for unusual items was $8.29, representing 49% year-over-year growth.

The Q4 had unusual expenses related to legal expenses, our previously disclosed 2018 performance share modification and corporate restructuring. Turning to our sales outlook for 2023, as Brian mentioned, we've seen a transaction trends turn positive as we remain focused on delivering a great guest experience. January comps were in the low double digits. For Q1, factoring in momentum we've seen quarter to date, as well as tougher comparisons as we move through the remainder of the quarter, we anticipate comp sales to be in the high single-digit range. While it's difficult to forecast comps for the rest of the year, considering economic uncertainty, including the possibility of recession, we expect comps to moderate as we lap menu price increases in early Q2 and the middle of Q3.

I'll now go through the key P&L line items, beginning with cost of sales. Cost of sales in the quarter were 29.3%, a decrease of about 230 basis points from last year. The benefit of menu price increases and lower avocado prices offset elevated costs across the board, most notably in dairy, tortillas, beans, rice, and salsa. In Q1, we expect our cost of sales to be in the high 29% range due to higher prices across several items, including queso, salsa, spices, and oils. Labor costs for the quarter were 25.6%, a decrease of about 80 basis points from last year. The benefit of sales leverage was somewhat offset by wage inflation, in addition to higher than expected sick pay and medical claims.

For Q1, we expect our labor costs to improve slightly, but remain in the mid 25% range due to seasonally higher employee taxes, as employee taxes start the year at an elevated level due to resetting of wage caps. Other operating costs for the quarter were 15.7%, a decrease of about 60 basis points from last year. This decrease was driven by a decline in delivery expenses due to lower delivery sales, as well as sales leverage, partially offset by higher costs across several expenses, including natural gas and maintenance and repairs. Marketing and promo costs for the quarter were 3.4%, 20 basis points below last year. In Q1, we expect marketing costs to be in the mid 3% range, with the full year to come in around 3%.

In Q1, other operating costs are expected to be in the low 15% range. G&A for the quarter was $135 million on a GAAP basis, or $129 million on a non-GAAP basis, excluding $4 million in legal expenses, $1 million related to the previously disclosed modification to our 2018 performance shares, and $1 million related to transformation expenses. G&A also includes $119 million in underlying G&A, $18 million related to non-cash stock compensation, which includes a reduction in the estimated payout levels of our performance-based stock awards, and was offset by $8 million reduction in performance-based bonus accruals.

We expect our underlying G&A to be around $121 million in Q1 and continue to grow slightly thereafter as we make investments in technology and people to support ongoing growth. We anticipate stock comp will be around $25 million in Q1, although this amount could move up or down based on our performance and is subject to the 2023 grants, which are issued in Q1. We also expect to recognize around $7 million related to employer taxes associated with shares that vest during the quarter and $2 million for costs associated with our field leader conference in February, bringing our anticipated total G&A in Q1 to around $155 million. Depreciation for the quarter was $74 million, or 3.4% of sales.

For the full year 2023, we expect it to inch up slightly each quarter as we open more restaurants. Our effective tax rate for Q4 was 26.3% for GAAP and 25.1% for non-GAAP. For 2023, we continue to estimate our underlying effective tax rate will be in the 25%-27% range, though it may vary based on discrete items. Our balance sheet remains strong as we ended the quarter with $1.3 billion in cash, restricted cash and investments with no debt, along with a $500 million untapped revolver.

During the Q4, we repurchased $199 million of our stock at an average price of $1,487. We repurchased a total of $827 million in 2022, which was the largest amount ever repurchased in a single year. We increased our level of stock repurchases during the quarter when our share price fell with the market overall. We'll continue to opportunistically repurchase our stock.

Brian Niccol (Chairman and CEO)

During the quarter, our board authorized an additional $200 million to our share authorization program, and at the end of the quarter, we had $414 million remaining. We opened a record 100 new restaurants in the Q4, of which 90 had a Chipotlane. We remain on track to open 255-285 new restaurants in 2023, with at least 80% including a Chipotlane. Development delays remain a headwind, including utility installation, permitting and inspection delays, construction and labor challenges, and component and raw material shortages. While we expect these challenges to persist into 2023, our pipeline remains strong and we expect to move toward the high end of the 8%-10% openings range once these headwinds subside.

To conclude, we're off to a strong start in 2023 with early signs of progress from our focus on getting back to the basics of running great restaurants and treasuring our guests. While we cannot predict how the macroeconomic environment will play out over the next 12 months, we will continue to strengthen our operations and work hard to earn each and every customer visit. I want to thank our restaurant teams and our restaurant support teams for all their hard work this year and for their commitment to Chipotle. With that, we're happy to take your questions.

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question will be from David Tarantino from Baird. Please go ahead.

David Tarantino (Senior Research Analyst and Director of Research)

Hi. Good afternoon. I have a couple of questions about your commentary on traffic trends. I think, Brian, you mentioned that underlying traffic trends have turned positive, if I heard that correctly. I'm wondering what you meant by the word underlying, if you're making some adjustments to that. I know January, you know, had a lot of puts and takes, you know, with respect to the comparison, you know, against Omicron last year, and then perhaps we had some favorable weather this year. I'm wondering, you know, it seems like you're linking some of their traffic progress towards some of your internal initiatives, and I'm wondering how you're adjusting for some of the factors that maybe were outside your control.

Brian Niccol (Chairman and CEO)

Yeah. First of all, underlying just means transactions. There wasn't anything there, thanks for asking for the clarity. Basically what we saw is as we exited the quarter, our transactions turned positive, we saw that continue to build in January. You're right, there's some Omicron, there was some good weather. What we've also seen is our staffing is at the best it's been. Our turnover is at the best it's been in two years. You know, I think the combination of focusing on the basics, meaning, you know, no menu deactivations, keeping the lines open, both our front line and digital make line from open to close, teams deployed correctly, is also a key driver in why we're seeing the traffic progress in January throughout that whole month.

We're feeling good about where we are, operationally. We believe we can still get even better, as we get closer and closer to our, you know, infamous burrito season. It's a great position of strength that we're walking forward from. We like how we exited December, and we like how January shaped up.

David Tarantino (Senior Research Analyst and Director of Research)

Great. If I could just ask one follow-up on the operations. I'm wondering if you could maybe elaborate on what metrics other than transactions that you're focused on and how those are progressing and what you think maybe the, you know, ultimate target for those should be, you know, as you progress through the year or maybe work towards your goals there.

Brian Niccol (Chairman and CEO)

Like, to put a little color on this, you know, menu deactivations in our digital business. Obviously, during the course of the last two years, we've had a lot of supply chain challenges, one of the workarounds we created was allowing teams to deactivate certain items, right? Whether it's guac or chips or, you know, anything on those lines. We've kind of just reestablished with both our suppliers, our distribution partners, and our teams that that's not a fallback position anymore. The expectation is. I don't know. Can you hear me, David?

David Tarantino (Senior Research Analyst and Director of Research)

I can. Thank you.

Brian Niccol (Chairman and CEO)

Okay. The expectation is you should be in stock, and then you should be prepared from open to close with those items. You know, there were points and times during that quarter where we had hundreds of menu deactivations, and now we're back into, you know, the single digits on how that's going. That's a key metric. Another key metric would be our digital on-time percentage. That's improved by nearly 10 points. I think that's a function, again, of being deployed correctly, staffed correctly, and then obviously having the ingredients you need in order to build the order correctly. We've seen some progress on throughput as well on the front line.

I anticipate really where we'll see big movement on throughput is more towards the Q2 when we get into kind of more of our peak performance. That's why you saw us focused on hiring so many additional people. There's a lot of good indicators beyond just the traffic trends that we've seen. You know, I always like to start with, hey, if you got more stability, your teams are deployed correctly, they're trained correctly, and then we keep it very focused on the basics of running the restaurant, we know we get good outcomes.

David Tarantino (Senior Research Analyst and Director of Research)

Great. Thank you very much.

Operator (participant)

The next question is from Sara Senatore from Bank of America. Please go ahead.

Sara Senatore (Managing Director and Senior Research Analyst)

Hi. Thank you. I have a follow-up on labor and staffing, a quick one on the new unit. Just on the labor piece, I guess could you help me reconcile I think, you know, you've been saying mid-single-digit wage inflation, and I think you had something like 15% price on the menu. Were those hours coming from what you were talking about, like, the sort of shoulder-to-shoulder job training or is that 90% staff, you know, 90% fully staffed? Is that a lot higher than it was? Just trying to think about as, you know, we look forward to the year if there should be more labor-hour investments.

Brian Niccol (Chairman and CEO)

Yeah. Well, I think what we've been referring to more often than not is just the absolute wage that we're paying and then what that inflation subsequent with that has been. You know, the stores, fortunately are... We keep track of an at model metric, and that's what we're referring to, where we're closing on 90% of our restaurants being at model. You know, in regard to the shoulder-to-shoulder training, you know, that's just part of our process. I think there was an element at some point where we were maybe getting too reliant on virtual training versus the shoulder-to-shoulder training, meaning our field leaders, our team directors also need to be in the restaurants doing shoulder-to-shoulder training with our general managers and our new crew. That should not result in any additional labor cost with having more shoulder-to-shoulder training.

Jack, I don't know if there's anything you want to add to that?

Jack Hartung (Chief Financial and Administrative Officer)

No, I think that's right, Sara. We don't think we need to add incremental investment in labor for the training because the best training is, you put your teams in position. You have somebody that shows them what to do, and you have somebody that's watching them to kind of self-correct along the way. It shouldn't be extra labor per se. When we hire 15,000 people, there's gonna be some additional training, I don't think it's gonna be anything that you'll see will, you know, blow up the labor line or the P&L going forward at all.

Sara Senatore (Managing Director and Senior Research Analyst)

Okay. just as we're thinking about kind of the labor, you know, there's still room, I think what you're saying, for improvement on just the restaurant level margin line...

Jack Hartung (Chief Financial and Administrative Officer)

Yeah, definitely.

Sara Senatore (Managing Director and Senior Research Analyst)

if you comp. Okay.

Jack Hartung (Chief Financial and Administrative Officer)

Yeah.

Sara Senatore (Managing Director and Senior Research Analyst)

Just quickly on the new store productivity, could you clarify, you said sort of there it's 1,000 basis points better. Is that because the Chipotlanes open at higher volumes than non-Chipotlanes, it's just sort of comparing the different models? Or is there something else going on where across the board, new store productivity is better? Thank you.

Jack Hartung (Chief Financial and Administrative Officer)

Yeah, yeah, Sara, I'll take this. I think it's really more based on the Chipotlanes, 'cause if you look over, you know, the last four years or so, you gotta look over a longer period of time to look at all the openings. We've moved up our productivity. For example, today, our restaurants open up on average around 85% of what our existing, you know, comp stores are doing. If you look back three or four years ago, we were in kind of the high 70% range or so. There's been a step change. The biggest thing that's happened from, you know, three and a half years ago to today is we've moved from having just a handful of Chipotlanes to having the majority of our portfolio is Chipotlane.

We still, when we look at what our Chipotlanes are doing, the 85% compared to the 15% without a Chipotlane, they continue to outperform that non-Chipotlane cohort. We think the main driver, you know, is the Chipotlane and the convenience that our customers find with that, you know, digital drive-thru.

Sara Senatore (Managing Director and Senior Research Analyst)

Thank you so much.

Operator (participant)

The next question will be from David Palmer from Evercore ISI. Please go ahead.

David Palmer (Senior Managing Director and Restaurant and Food Analyst)

Thanks. Wanted to ask a question about digital orders. You know, I've been somewhat surprised by the level of decline there. I think back in the Q3, we estimated that digital traffic per store declined in the mid-teens. That's including both delivery and pickup. Maybe you can comment on whether you think that was correct. Also, how much you think digital traffic per store declined in the Q4. Just relatedly, you know, what are your thoughts about that channel? I know it's important to you. You know, what's your outlook for it, and are there things you can do to stabilize that line? Thanks.

Jack Hartung (Chief Financial and Administrative Officer)

Yeah.

Brian Niccol (Chairman and CEO)

Go ahead, Jack.

Jack Hartung (Chief Financial and Administrative Officer)

Well, yeah, I'll get started, David. Listen, there's a couple things that are driving it. One is we're having a surge in return to in-restaurant. That part of our business is growing very, very healthily, you know, throughout the last year and a half or two years since, you know, we've been moving away from the pandemic. Secondly, delivery has been declining as well. Delivery transactions in the Q4 declined 15%, and that's, I think, been just again, a normal kind of move away from people getting out and about. I think there's probably some people who are deciding that while that channel adds a lot of convenience, there's a, you know, higher price that comes with that. Those are the two main drivers.

You know, we figured that digital would kind of settle in this high 30% range. We're at 37% range now. It's, it's within the range that we thought we would be in. Early on in the pandemic, we saw our two markets that were the least affected, that'd be the Southeast and the Southwest. When they were starting to normalize, they were normalizing towards that high 30% range. It, it feels like about the right range for us.

David Palmer (Senior Managing Director and Restaurant and Food Analyst)

Is your view that you're gonna start to kinda lap the Q2, things really step down? Or do you think you're gonna enjoy that comparisons when it comes to digital orders and start to stabilize on that channel and then perhaps enjoy some of the benefits you're talking about with throughput on the front make line? If that is your belief.

Jack Hartung (Chief Financial and Administrative Officer)

That's right.

David Palmer (Senior Managing Director and Restaurant and Food Analyst)

yeah, that you're gonna get-

Jack Hartung (Chief Financial and Administrative Officer)

Yeah.

David Palmer (Senior Managing Director and Restaurant and Food Analyst)

the dual benefit there?

Jack Hartung (Chief Financial and Administrative Officer)

Yeah, that's right, David. I mean, the way we think about it is we feel like we've reset the delivery business to be now where it makes sense economically. You know, as such, you know, our order ahead business, I think, has started to show, you know, the right trajectory. Obviously our in-store business has shown tremendous acceleration. I think you said it well.

Brian Bittner (Managing Director and Senior Equity Analyst – Restaurants)

Thank you.

Operator (participant)

The next question is from Andrew Charles from Cowen. Please go ahead.

Andrew Charles (Managing Director and Research Analyst)

Great. Thanks. Jack, I have two margin questions for you. There's obviously a lot of noise in four Q labor costs plus one Q guidance for labor. I'm curious what the impact of higher than expected sick claims had on four Q. I missed the term, but there's some external factors that you're embedding, you know, within the mid 25% labor margins. Can you just help tease us out in terms of what that impact is from that external factor? My real question is if we zoom out and fast-forward to when you get to $3 million sales volumes, what's your level of confidence in achieving 27% restaurant level margins relative to what you might have said a quarter ago?

As you know, the sales trajectory has obviously been, you know, up and to the right. You're rapidly getting towards that target.

Jack Hartung (Chief Financial and Administrative Officer)

Yeah. Let me start with the Q4. Our expectations were that our margin would be more in the 25% range rather than the 24% range. When you look at the pieces of, you know, how we, how we got down to 24, you know, part of it was the loyalty breakage. You know, frankly, there was an 80 basis point change year-over-year in the comp related to just that journal entry that we had to book for the breakage. If you look at just there was 30 basis points of additional, or reduced breakage that we had to reflect this year. That cost us 20 basis points on the margin.

It was 60 basis points on we saw higher than expected medical claims, and sick pay during the quarter as well. We typically do see those things, pick up a little bit in the Q4, and especially in December, but you know, the surge was more than we expected. That's not something that we would expect to recur. Sales softened during December as well. I think that went hand in hand with softer retail sales. We know there was some weather and you know, a seasonal shift in the holidays and things like that, and that was 20-30 basis points or so.

We look at that margin in the Q4, and we think if those things normalize, there is as much as 100 basis points or so that we can get back. We won't get it back all at one time, but we definitely think we have the potential to do that. With that in mind, if you're looking at more that high 24s and that 25% range on a normalized basis, then we are confident that as we move from the current volumes on a menu price adjusted basis, just over $2.7 million up towards that $3 million, the flow-through that we know our model provides will still get us to that 27%.

Andrew Charles (Managing Director and Research Analyst)

Can you just clarify? I'm sorry, you said sales were a bit softer than you guys expected December, but I think early in the script you guys talked about how there was improvement through the quarter. Was that just a reflection that December didn't perform to the level you guys were really expecting?

Jack Hartung (Chief Financial and Administrative Officer)

Yeah. I mean, listen, the way I would describe the quarter, we started out soft, and we talked about that in October, that we were doing a mid-single digit comp that, you know, GGS, while there was an attachment rate that was as expected, it wasn't driving transactions. We started out, you know, soft in the quarter. We picked up as we stopped comparing against brisket. That was in the middle of November. We had, call it, you know, high single digit comps for a while, and then we lapped the menu price increase from December of 2021. Just as we got around the holiday, we just didn't see that, you know, that pop, that, you know, momentum that we normally see.

You know, the way I would describe it is, frankly, we started the quarter soft, and we ended the quarter soft. What we're happy about is as the holidays, we got through the holidays and we got into January, that's where our transactions, not just from a comparison standpoint, but just on a trend month-over-month, really did improve. We feel good about where we go from here. Yeah, listen, the Q4 was a tough quarter for us.

Andrew Charles (Managing Director and Research Analyst)

Thanks for the call, Jack.

Operator (participant)

The next question will be from Brian Bittner from Oppenheimer & Co. Inc. Please go ahead.

Brian Bittner (Managing Director and Senior Equity Analyst – Restaurants)

Thank you. Thanks for the question. As you move throughout 2023 and you lap, you know, some of these large menu price increases as the year progresses, would you know, think about replacing them with some type of increases, albeit probably a lot more normalized, more lower price increases, or do you plan to let these fully roll off? Jack, as you sit here today, what do you anticipate the total pricing factor to be for the full year 2023 for the same store sales model?

Jack Hartung (Chief Financial and Administrative Officer)

Yeah. I mean, I'll start with that, and then we can talk about, you know, expectations. You know, we're running right now in that kind of 9%-10% range. As I mentioned, it rolls off early in Q3 and then in, you know, I'm sorry, early in Q2 and mid Q3. Then there were a couple delivery, you know, adjustments, target adjustments, you know, in there as well. We'll end up being somewhere in that kind of mid-single digit, because by the time you get to, you know, the end of the year, we're running basically 0 pricing. Overall for the year, it'll be somewhere in that kind of mid-single digit.

In terms of, you know, in terms of pricing action, we're not gonna take a price increase just to cover a lap over last year. The main thing we're gonna do is we're gonna watch inflation, and we're gonna hope that inflation is tame. You know, right now we know that there is some pressure on a few of our ingredients. Beef is the one that we keep hearing about. We haven't seen it yet, but everyone is predicting that there's going to be greater supply versus demand. We'll watch that carefully and see what inflation does. It's gonna be more about

Inflation in wages, inflation in ingredients, do we need to take pricing action to cover some of that? We wouldn't take a price increase just to cover a comp lap.

Brian Bittner (Managing Director and Senior Equity Analyst – Restaurants)

That makes sense. Just, just a clarification on the, on the same-store sales guidance for the Q1. I know you've talked a lot about traffic flipping positive here in January, but if we just hypothetically land in that high single digit range for the Q1, what do you think mix and traffic would separately be in that build if it kind of played out how you thought?

Brian Niccol (Chairman and CEO)

I mean, right now we're running, call it mid-single digit positive traffic. We expect for the quarter, that guidance range assumes that we're also gonna be, you know, positive transactions more in the low-single digit as we move away from Omicron. Pricing will be that 9%-10% range that I mentioned. There's gonna be a mix component. We think it's kind of probably be in that low, maybe 2%-3%, something like that. Mix is a little harder to predict. Those are the main components.

Brian Bittner (Managing Director and Senior Equity Analyst – Restaurants)

Great. Thank you.

Operator (participant)

Thank you. The next question will be from Jon Tower from Citigroup. Please go ahead.

Jon Tower (Director of Equity Research – Consumer/Restaurants)

Great. Thanks for taking the question. Quick clarification on a question. On the new store productivity, I know we talked on this a little bit earlier. During the quarter, was there anything about timing where, based on the way that we can calculate it looked like the productivity of the stores might have been a little bit lower than the normal. I don't know if that's related to timing or something else. That's kind of the clarification. The question is then on thinking about the Garlic Guajillo Steak. You know, it didn't live up to your expectations. Curious if you could dissect that and give us a reason as to what you might have missed. I know it hasn't been that long, but curious to know how it didn't perform versus your expectations and why you think that happened.

Brian Niccol (Chairman and CEO)

Well, I'll let Jack answer the first one on the store productivity...

Jon Tower (Director of Equity Research – Consumer/Restaurants)

Yeah.

Brian Niccol (Chairman and CEO)

I can chime in on the.

Jack Hartung (Chief Financial and Administrative Officer)

Yeah. You hit the nail on the head. You know, we opened a record 100 restaurants during the quarter, but it was very backloaded. Our teams did a great job of just scratching, clawing, and doing everything they could to get the restaurants open and, I think we probably had a record opening in the month of December as well. You know, we had more than half of the openings were in the last month of the year. Yeah, you didn't see a typical sales flow through considering we opened 100 restaurants.

Jon Tower (Director of Equity Research – Consumer/Restaurants)

Thank you.

Brian Niccol (Chairman and CEO)

On your question about Garlic Guajillo Steak. You know, look, I think it's one of those things where we tested it in a very different environment than when we rolled it out. You know, as a result, we got the check benefit, but we didn't get the transactions. You know, it also had the challenge of rolling over brisket, which was arguably one of our best performing menu items that we've done to date. You know, we'll continue to analyze so that we make sure we learn from it going forward, and that's why we use the stage gate process so that we are always learning.

Operator (participant)

Thank you. Our next question will be from Sharon Zackfia from William Blair. Please go ahead.

Sharon Zackfia (Partner, Head of Consumer Equity Research, and Analyst – Restaurants, Lifestyle, and Leisure Brands)

Hi, good afternoon. I wanted to ask a question about staffing and the lower turnover that you're seeing. Is there a way to kind of compare and contrast tenure on the frontline now versus 2019? If we think about throughput opportunity as we enter high season, I mean, how much is the frontline, because it is less experienced, kind of lagging where you were in 2019 or dimensionalize kind of how much throughput opportunity is really on the table here as you have, you know, more productive frontline staff?

Brian Niccol (Chairman and CEO)

Yeah. Look, thanks for the question on this because I think this is an important one, which is what we, what we know is when we have our teams at model and deployed correctly with leadership present for shoulder-to-shoulder training, our restaurants perform. That's what we saw, you know, in 2019, and that's what we anticipate occurring going forward. You know, we know there's upside in how much throughput is, you know, our teams are capable of doing. You know, obviously, we're targeting to get those throughput numbers back to where they were in, call it, the 2019 time period.

The one thing that's nice is our turnover levels have dropped, so we're getting more stability in the teams, which means they're getting more reps, so that as we walk into these higher, you know, level or higher volume months, they've got more reps and being deployed correctly, working together correctly to ensure that we get more throughput. So that's what we're focused on, is the people that we have today, how do we get them trained, how do we get them deployed, and then how do we make sure those teams stay together. Yeah. Sharon, just to add, you know, when we look at the time and position back to 19, and there's 2 factors here. 1 is turnover, the other 1 is promotion rates as well.

When your turnover slows down, people are gonna be in their position longer. In, for example, on the kitchen manager, we're very close to where we were in 2019. The average tenure in the kitchen manager role was like 0.69, meaning it was about eight months or so. Today it's like 0.64. It's like maybe seven, seven and a half months, something like that. In apprentice, we're not quite back to 2019, but we're ahead of where we were a year ago, and we're within striking distance again. You know, those are areas that, you know, we were seeing that our average tenure was going down, you know, during the high turnover period of the last, you know, year and a half or so.

Those numbers appear to just like with the turnover, be stabilizing and moving back up.

Operator (participant)

Thank you. The next question will be from John Ivankoe with JPMorgan. Please go ahead.

John Ivankoe (Managing Director and Equity Research Analyst)

Hi, thank you. I know you've been working on a number of different automation or technology practices in the store that could potentially reduce the demand for labor and also make you more efficient and perhaps more consistent in some ways. I was just hoping you could take a few minutes or a few seconds and just kind of talk about some of the different packages that you have, how far along they are, and when we actually might be able to start to see, you know, some benefit, even if it's on a limited basis, at a market level. Thank you.

Brian Niccol (Chairman and CEO)

Yeah, sure. Probably the one that's closest in is the new grill work that we've got going on, which I mentioned in my earlier remarks. You know, it just gives our teams a tool that allows them to cook the chicken, frankly, just perfect every time and a lot faster, you know, significantly faster. The same thing goes for steak. We're actually moving that from a one store test now to a multi-store test, you know, as we speak. We're excited about that one. Obviously, we're working on a automated digital make line, which is in partnership with Hyphen, and we'll get the first one of those into a real live prototype in our Cultivate Center by the end of this quarter, early in the next quarter.

That one's a little bit further out. We just got rolling with a live pilot on the what we call Chippy, which is our automated arm or robotic arm to fry chips. I'll have much more information on that as that goes live in the one restaurant. You know, I'd say the one that's probably closest in is the grill, and the one that's probably furthest out probably is our digital make line, automated digital make line. All of these are really promising because then when you can significantly reduce cook times and then make the practice of grilling chicken and steak easier, good things happen with our culinary. That's what we've seen in the one restaurant. You know, people are giving us feedback that the steak and chicken taste great.

Our team members are giving us feedback that they love using the new grills. You know, when we're more consistent with great culinary, everybody wins.

John Ivankoe (Managing Director and Equity Research Analyst)

Thank you.

Operator (participant)

The next question will be from Dennis Geiger from UBS. Please go ahead.

Dennis Geiger (Executive Director and Equity Research Analyst – (Restaurants))

Thank you. Just first wondering if it would be possible to give the traffic mix price for the 4Q. The question is really about pricing, another one on pricing. Just curious if you believe you've seen any customer resistance to pricing levels, you know, how that's kind of been shaped, how you thought about the pricing that you talked about for the year, and, you know, related to that, any kind of update on value scores, the low-income customer that you spoke to last quarter, anything as it relates to shaping your view on how the business performs into a potentially tougher macro. Thanks, guys.

Brian Niccol (Chairman and CEO)

Yeah, sure. Look, we really have not seen any meaningful resistance to our pricing, especially as it relates to our in-store experience. Obviously, you know, the delivery channel was down, but I think that's a function of a couple things. One, you do have to pay a premium for that occasion, combined with that the in-store experience is back and people are back out and about. Potentially, you know, they see the convenience, the customization of coming in the restaurant and getting it on kind of their controlled terms. You know, we continue to see the higher income consumer, you know, the individual that earns over $100,000 coming more often. Frankly, I think the same thing would have happened with the low-income consumer, regardless of what the pricing was that we acted on.

You know, we made the decision not to go chasing people with discounts. That's not what our brand is, and that's not what we're gonna do. We're better off winning the value game through great culinary, great speed/convenience, terrific customization, and we know that continues to resonate. Our value scores continue to be really strong. If you look at people that I would say are comparable, you know, that are in the fast casual category, we're still at 10%-30% discount. You know, look, I think we've made a lot of really good moves to kind of move with the challenges that we've had to deal with.

You know, as a result, I think we're seeing stronger operations, stronger teams, and, you know, we're seeing, I think that work come out to bear in January and, you know, where we are here in February. You know, Jack, I don't know if there's anything to add to that.

John Ivankoe (Managing Director and Equity Research Analyst)

No, I think you said that perfectly, Brian. Just, I think you were looking for the components in the quarter. You know, the components are pricing was about 13.5. Transactions were down about four. Mix was down about three. That gets you to an underlying comp about 6.5%. We had a journal entry that deals with breakage, and that was 80 basis points. That gets you to the 5.6% comp.

Dennis Geiger (Executive Director and Equity Research Analyst – (Restaurants))

Great. Thank you, guys.

Operator (participant)

Our next question is from Jeffrey Bernstein with Barclays. Please go ahead.

Jeffrey Bernstein (Equity Research Analyst)

Great. Thank you very much. First question is just on the restaurant margin. You know, for full year 2022, you ended in that 24% range, though you talked about maybe some headwinds in the Q4 that brought that in below expectation. Just wondering if you can give any specific thoughts as you look to full year 2023.

I know you gave some color specific to the Q1, but as you think about the environment going forward, your pricing perhaps rolling off by the end of the year and what you know today based on kind of the key cost pressures, and was wondering your thoughts on the full year 2023, whether it's reasonable to assume a return to 25% plus in 2023 or beyond. I know you mentioned getting to more like 27% when you hit the $3 million, just wondering kind of on the interim, what you're thinking specifically to 2023.

Brian Niccol (Chairman and CEO)

Yeah, I mean, it's so hard. The reason we gave, you know, some color on the Q1 but not beyond that is we don't know what's gonna happen to the economy. We think inflation will be, you know, reasonably tame. You know, hopefully that will, that will come true. It. You know, we haven't made any decisions on pricing action right now. Jeff, the way I would think about it is we're gonna kind of let the year play out. We're gonna do everything we can in terms of managing the supply chain, managing as we recruit, you know, people. We've gotta pay the wages to, you know, make sure that we gear up for burrito season. We'll watch how the inflation element plays out.

We don't have any plans right now to take pricing action, so we might be, you know, more patient this year than we were last year. Last year, the inflation kept coming at us, and then we could see more ahead. We take pricing action, we'd see even more ahead. It doesn't feel like it's, you know, at that fever pitch, so I think you could see us being more patient this year. What I can tell you is when things do normalize, whether that's later this year or into 2024, we absolutely have, at these kind of volumes, the ability to get a margin up into that 25% range on a sustainable basis, and then it'll grow from there.

I just don't wanna make any promises on a quarter-by-quarter basis, just because so many things have happened in the last several quarters, and it's hard to predict what's gonna happen. I do know that our model is intact.

Jeffrey Bernstein (Equity Research Analyst)

Understood. Just following up on a couple of bigger picture topics. I think, Brian, you mentioned that international growth's gonna be at, I think you said, a measured pace. I'm wondering if the headwinds, to your point about the economy in Western Europe perhaps, is the primary reason why it's measured or maybe there are other causes for concern. Anything around that international acceleration and when the timing of that might be would be great. Thank you.

Brian Niccol (Chairman and CEO)

Yeah, sure. Obviously, Canada, it's full steam ahead, right? We're opening, I think, the most restaurants we've ever opened from a percentage standpoint and probably absolute standpoint, ever in Canada, which is really exciting. Those economics continue to perform really well. When you look at Europe, look, the top line is really performing, you know. Frankly, we've been much more patient on pricing there because we wanna make sure that people have the experiences with Chipotle. You know, there's a lot of inflation that we're still dealing with in Europe. Look, we like what we're seeing. You know, the good news is feedback on the experience is really very positive. Feedback on the culinary is very positive. The most recent restaurants that we've opened are performing really well.

You know, we're just taking our time with it because, unfortunately, you know, the last 3 years have not been normal in any way. We just wanna make sure we aren't getting any false positives or false negatives on any part of the business. The good news is we've got a tremendous growth runway in the United States, that we can be, you know, very patient with how we approach our international expansion. Look, the early signs are people like burritos and bowls, and they like our culinary, and they like the convenience, and they like the speed. That's a recipe for a lot of opportunity down the road.

Operator (participant)

Thank you. The next question is from Danilo Gargiulo with Bernstein. Please go ahead.

Danilo Gargiulo (Senior Analyst)

Great. Thank you. If I understand correctly, the traffic improvement you're seeing seems to be stemming primarily from productivity and operational improvements also as you're moving along in 2023. I'm wondering your expectations on the demand side from consumers and, in particular, whether you're seeing or expecting any trends that could be possibly offsetting the productivity and operational improvements as we are moving along in 2023.

Brian Niccol (Chairman and CEO)

No. You know, look, the consumer demand, especially if we use kind of our in-store experience right now, looks to be, looks to be there. You know, especially as you look at the higher income consumer, their purchase frequency has actually gone up. You know, we fundamentally believe the better we operate, the better our performance will be. That's why we've got, you know, Scott and the team have a full court press, frankly, on, you know, great people, great culinary. If we do those two things against our operating standards, you know, we believe we'll continue to make progress on throughput and we'll continue to see, the gains that hopefully we're experiencing in the first part of this quarter.

Danilo Gargiulo (Senior Analyst)

Thank you. I think you also mentioned there are some positive signs that are emerging from Project Square One. I was wondering if you can elaborate on that one and maybe, like, share a couple of metrics where you're particularly proud of?

Brian Niccol (Chairman and CEO)

Yeah. Look, I mentioned this earlier. Obviously one of the things that we've seen is a lot less incidents of menu deactivations. When you go to order online, you know, all the products are available, you know, chips, guac, chicken, steak, that has dramatically decreased. We know that's a big deal because when you order online, if you don't have what you want available, your conversion rate goes down. We've seen when we have the products in stock, our conversion rate gets back to where it should be. We've also seen a huge step up in our on time, percentage on time, in a meaningful way.

We've also already seen some progress on throughput, albeit small movement, but I think that has more to do with the time of year than a testament to the impact of Project Square One. What I also think is also really great news is we have more stability in our teams than we've had in over two years. We've got more teams at model with less turnover, and I think Scott's got these teams focused on deploying correctly and getting trained shoulder to shoulder so that they're ready to go when the rush shows up.

Operator (participant)

Thank you. Our final question today will be from Brian Harbour from Morgan Stanley. Please go ahead.

Brian Harbour (Equity Analyst, Executive Director – Restaurants and Food Distribution)

Yeah, thank you. Maybe first just a question on delivery. Are you able to see in your data that those customers have shifted to coming into the stores or mobile order ahead? Do you think those customers have basically fallen off as you've seen that business decline a little bit?

Brian Niccol (Chairman and CEO)

You know, what it looks like to us is we've definitely seen people make a shift to in-restaurant, and then some shift to order ahead. You know, that's probably been the biggest trends that we've seen. You know, obviously, the premium, especially when you operate in our white label execution, is one of those places where you can quickly compare, like, what's the difference between ordering delivery versus ordering pickup. You know, that's an obvious one where I think we've seen, as a result, people, they toggle between the two, and then they choose order ahead. Yeah, we've seen people stay committed to the idea of getting Chipotle. I'm sure there are those customers where if something's, you know, free somewhere else for delivery, they might take advantage of a freebie.

Look, we're not interested in renting or borrowing customers. We want people to be a part of the Chipotle business because the value proposition's right for them. They, they buy into, you know, the food that we provide, the culinary that we provide at the convenience and speed at which we provide it. That's been a conscious choice, and I think it's gonna serve us well in the long run.

Brian Harbour (Equity Analyst, Executive Director – Restaurants and Food Distribution)

Okay. maybe just a related question on kind of some of the new perks that you rolled out, Freepotle that you launched in January. I mean, is it your view that that drives kind of a step up in frequency? Or how else do you think it'll affect customer behavior? Is there any margin impact of that? I guess, you know, also it sounds like you've seen kind of mobile ordering stabilize, but do you want that to grow as you go into the next couple of years, and do you think this can kind of be a catalyst for that?

Brian Niccol (Chairman and CEO)

Yeah. Look, it's doing two things. One, it's hopefully keeping more people engaged in the loyalty program. You know, we're only, what, one month in on it. Also acquiring more people into the rewards program. It looks really promising that it's doing exactly what we want it to do. Again, it's only one month in. What was your second part of your question?

Brian Harbour (Equity Analyst, Executive Director – Restaurants and Food Distribution)

Just if you think that, you know, that's kind of the next catalyst for.

Brian Niccol (Chairman and CEO)

Oh.

Brian Harbour (Equity Analyst, Executive Director – Restaurants and Food Distribution)

greater mobile ordering penetration.

Brian Niccol (Chairman and CEO)

Yeah. Yeah. Yeah. Look, what we definitely know is when people are engaged in our Rewards program, we get more purchase frequency out of them. The most engaged people come through our digital business when it comes to our Rewards program. I do think the combination of, you know, high engagement with Rewards, specifically around the amount of personalization that we're doing here, will result in more frequency out of customers down the road. Usually that comes via a digital experience is where you see more of the impact from the Rewards program.

Brian Harbour (Equity Analyst, Executive Director – Restaurants and Food Distribution)

Thank you.

Operator (participant)

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to Brian Niccol for any closing remarks.

Brian Niccol (Chairman and CEO)

Okay, thanks. Thanks everybody for all the questions and being a part of the call. Obviously, you know, 2022 was another one of these years where a lot of unexpected things occurred. I do think, once again, we've demonstrated the resiliency of Chipotle and the power of our food with integrity purpose, combined with the culinary and convenience that we provide. You know, again, we were able to expand our AUVs, our margins. We had a record number of store openings in the Q4. You know, we're optimistic about where the business is today because of the focus on great operational execution combined with great culinary and great people.

You're gonna continue to see us stay focused on executing those basics while we continue to execute against the other strategies to make the brand more visible, loved, and hopefully engaged with. You know, off to a good start in 2023, and we're optimistic about our growth runway going forward. Thanks everybody for being a part of the call, and we'll talk to you soon, I'm sure. Take care. Bye.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.