Chipotle Mexican Grill, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The interim financial statements are unaudited. Amounts below are in U.S. dollars; financial figures are rounded to millions unless stated otherwise.
Business context
Chipotle operated 2,178 restaurants at quarter-end, including 2,129 Chipotle locations in the U.S. and 49 other locations and concepts. The company reported one operating segment. Management said sales and profitability remained adversely affected by food-borne illness incidents associated with Chipotle restaurants, widely reported in late 2015 and early 2016.
Financial and operating results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $1,037.0m | $1,216.9m | $2,869.8m | $3,503.7m |
| Operating income | $9.7m | $234.8m | $4.0m | $660.0m |
| Net income | $7.8m | $144.9m | $7.0m | $407.7m |
| Diluted EPS | $0.27 | $4.59 | $0.23 | $12.92 |
| Operating margin | 0.9% | 19.3% | 0.1% | 18.8% |
- Q3 revenue fell 14.8% year over year; nine-month revenue fell 18.1%. Comparable restaurant sales declined 21.9% in Q3 and 24.9% for the nine months, although the Q3 decline improved from 29.7% in Q1 and 23.6% in Q2. Lower transactions were the main driver; Q3 transactions declined 15.2%.
- Q3 restaurant costs as a percentage of revenue increased: food, beverage and packaging to 35.1% from 33.0%; labor to 27.6% from 22.2%; occupancy to 7.2% from 5.5%; and other operating costs to 16.0% from 11.1%. Sales deleveraging, marketing and promotions, food-safety procedures, wage inflation and higher avocado prices contributed.
- Q3 included a $14.5m non-cash ShopHouse impairment charge ($8.5m after tax). Loss on disposal and impairment for the nine months was $22.0m, versus $7.7m a year earlier.
- Operating cash flow was $281.1m for the nine months, versus $588.6m. Capital expenditures were $192.3m; operating cash flow less capital expenditures was approximately $88.8m. Investing cash flow was positive $393.4m, including $540.6m of investment-sale proceeds. Financing cash outflow was $769.4m, primarily from share repurchases.
- At September 30, cash and cash equivalents were $154.1m, current investments $205.0m and long-term investments $250.7m. Total liabilities were $626.0m; the presented balance sheet lists no debt. Current assets were $468.9m and current liabilities $279.5m.
Changes, outlook and management commentary
- Average restaurant sales were $1.914m, down 24.4% from $2.532m. New openings partly offset comparable-sales declines: 171 restaurants opened in the first nine months, including 55 in Q3.
- Chiptopia Summer Rewards contributed positively to Q3 transactions, according to management, but $11.5m of revenue was deferred for unredeemed rewards. The program expired at quarter-end; management cautioned that it may not retain customers attracted by the promotion.
- Management expected Q4 2016 comparable sales declines in the low single digits and restaurant operating costs as a percentage of revenue to remain consistent with Q3. It expected 2016 openings at or above the high end of the prior 220–235 range.
- For 2017, management targeted high-single-digit comparable-sales growth, planned 195–210 openings and expected a 39.5% effective tax rate. It cited marketing and digital improvements, lower promotional spending, supplier terms, operational efficiencies and simpler restaurant designs as potential sales or cost drivers. These are forward-looking targets, not assurances.
- The company said it would not invest further in developing and growing ShopHouse and would pursue strategic alternatives. On October 25, 2016, the board authorized an additional $100m for share repurchases; $69.2m remained under earlier authorizations at September 30.
Risks, contingencies and unusual items
- A federal criminal investigation into food-safety matters was ongoing; the company said it would cooperate. It could not estimate potential fines or penalties.
- The filing describes a shareholder securities class action, multiple derivative actions and government investigations concerning employee work-authorization compliance and related disclosures. The company intended to defend or cooperate as applicable and could not reasonably estimate outcomes or potential liabilities.
- Management identified risks that marketing and promotions may not restore sales or retain customers, as well as risks involving key personnel, food safety, commodity prices and execution of digital and catering initiatives. The company reported no off-balance-sheet arrangements and no material change in risk factors except those described in the filing.
- The filing said adoption of the new lease accounting standard was expected to materially increase balance-sheet assets and obligations for operating leases. The stated 2017 tax-rate outlook was subject to volatility from stock-award activity under new stock-compensation accounting.
Important facts for investors to verify
- Whether comparable-sales and transaction trends continued to improve after Q3, and whether promotions translated into sustained customer visits.
- The extent to which food-safety procedures, marketing and sales deleveraging affect restaurant margins and cash generation.
- Developments and potential financial exposure from the food-safety, securities, derivative and work-authorization investigations and litigation.
- ShopHouse strategic alternatives, the scale of any further impairment, and the balance between repurchases, restaurant investment and liquidity.
- Actual opening pace, 2017 sales and cost performance, and the impact of lease and stock-compensation accounting changes.