Chipotle profit misses as food, legal costs weigh

LOS ANGELES Wed Jul 20, 2011 7:34am EDT

Women walk out of a Chipotle Mexican Grill restaurant in Redlands, California February 9, 2011. REUTERS/Lucy Nicholson

Women walk out of a Chipotle Mexican Grill restaurant in Redlands, California February 9, 2011.

Credit: Reuters/Lucy Nicholson

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LOS ANGELES (Reuters) - Chipotle Mexican Grill's (CMG.N) quarterly profit missed expectations for only the second time in its history after margins were hurt by higher food prices and legal costs related to a federal probe of illegal immigrant hiring.

The company also booked a significant investment-related charge, and its shares fell 4.3 percent in extended trading.

The burrito chain said publicity about the U.S. Attorney's criminal investigation into its hiring practices appeared to drive higher employee turnover in April and May.

Executives said turnover had begun to moderate in the last month or so and they expected it to return to normal levels.

Turnover now is running around 120 percent, higher than the company's normal rate of 100 percent, Chipotle said, adding that many rivals have turnover of as high as 160 percent.

Higher turnover results in higher labor costs and can slow down service.

"It worries us that we saw turnover increase recently," co-Chief Executive Monty Moran said on a conference call with analysts.

"I'm not expecting it to be a long-term problem, but it was a surprise in the quarter," William Blair & Co analyst Sharon Zackfia said of the higher turnover.

Analysts have said Chipotle executives have done a stellar job of holding down labor costs -- even as existing restaurants crank out higher sales.

Some investors have worried that Chipotle's labor costs could rise as it replaces illegal workers, erasing a cost advantage the company has had over many of its rivals.

Reuters reported in February that costs related to the company's immigration woes could send labor expenses higher.

COSTS RISE

Chipotle has long been a Wall Street darling, favored for its ability to hem in costs while expanding at a rapid clip. It is building restaurants all over the United States and is breaking into overseas markets like London and Paris. It also has promised to open ShopHouse Southeast Asian Kitchen, a new concept, later this summer in the nation's capital.

Its shares closed at all-time high of $333.71 prior to the company's financial report on Tuesday.

The company said legal costs related to its immigration woes had reached $1.3 million, and would continue to grow for the next few quarters.

In April, the company revealed that the criminal division of the U.S. Attorney's office for Washington, D.C., had opened an investigation and asked it to turn over documents related to U.S. Immigration and Customs Enforcement audits.

In the wake of ICE audits in Minnesota, Virginia and Washington, D.C., Chipotle fired roughly 500 undocumented workers.

The higher legal costs, as well as an increase in non-cash stock-based compensation, sent general and administrative costs up 80 basis points to 7.3 percent of revenue during the second quarter.

All U.S. restaurant chains are grappling with higher costs for important ingredients like beef, cheeses and produce. Unlike many other chains, Chipotle has said it is unable to lock in many prices because it uses natural and organic ingredients where possible.

Chipotle said food cost inflation, particularly for beef and avocados, was largely to blame for a 110 basis point decline in restaurant operating margins, which were 25.8 percent in the latest quarter.

The company has raised menu prices in many parts of the United States to help cover higher food costs and executives said they've seen no signs of customer resistance.

Second-quarter net income at the Denver-based company rose 9 percent from a year earlier to $50.7 million, or $1.59 per share -- a result that missed analysts' average estimate by 9 cents, according to Thomson Reuters I/B/E/S.

Spokesman Chris Arnold said the miss was only the second since Chipotle went public in January 2006.

More than half of the miss is due to a loss of 5 cents per share related to Chipotle's investment in Soul Daddy, a failed eatery that was the winner on "America's Next Great Restaurant" -- a reality television show on which its founder Steve Ells was a judge.

Second-quarter revenue rose 22 percent to $571.6 million. Closely watched sales at restaurants open at least 13 months were up 10 percent, fueled by an increase in customer visits and menu price hikes.

The company raised its full-year outlook for same-restaurant sales, but investors appeared to blow that off.

Chipotle's new 2011 forecast calls for a high single-digit to low double-digit percentage increase in sales at established restaurants. It previously said it expected a mid-single-digit percentage increase.

Shares in Chipotle fell to $319.50 in extended trade.

(Additional reporting by Nichola Groom and Mary Slosson in Los Angeles, editing by Bernard Orr, Gary Hill)

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