UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31,June 30, 2007

or

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period fromto

Commission File Number: 1-32731

 


CHIPOTLE MEXICAN GRILL, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware 84-1219301

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

1543 Wazee Street, Suite 200 Denver, CO 80202
(Address of Principal Executive Offices) (Zip Code)

Registrant’s telephone number, including area code: (303) 595-4000

 


Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

¨  Large accelerated filer    ¨  Accelerated filer    x  Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

As of April 26,July 27, 2007 there were 14,365,34014,410,477 shares of the registrant’s Class A common stock, par value of $0.01 per share, and 18,424,690 shares of the registrant’s Class B common stock, par value of $0.01 per share, outstanding.

 



TABLE OF CONTENTS

 

Page
PART I  2

Item 1.

 Financial Statements  2

Item 2.

 Management’s Discussion and Analysis of Financial Condition and Results of Operations  8

Item 3.

 Quantitative and Qualitative Disclosures About Market Risk  14

Item 4.

 Controls and Procedures  14
PART II  15

Item 1.

 Legal Proceedings  1415

Item 1A.

 Risk Factors  15

Item 3.2.

 Unregistered Sales of Equity Securities and Use of Proceeds  1516

Item 3.

Defaults Upon Senior Securities16

Item 4.

 Submission of Matters to a Vote of Security Holders  1516

Item 5.

 Other Information  1517

Item 6.

 Exhibits  1517
 Signatures  1618


PART I

 

ITEM 1.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Chipotle Mexican Grill, Inc.

Consolidated Balance Sheet

(in thousands, except per share data)

 

  

March 31

2007

  

December 31

2006

    

June 30,

2007

  December 31,
2006
  (unaudited)     (unaudited)   

Assets

        

Current assets:

        

Cash

  $158,902  $153,642

Accounts receivable, net of allowance for doubtful accounts of $344 as of March 31, 2007 and December 31,2006

   5,332   4,865

Notes receivable—McDonald’s Corp.

   48   8,783

Cash and cash equivalents

  $156,217  $153,642

Accounts receivable, net of allowance for doubtful accounts of $237 and $344 as of June 30, 2007 and December 31, 2006, respectively

   6,270   4,865

Notes receivable—McDonald’s Corporation.

   48   8,783

Inventory

   4,142   3,505   4,418   3,505

Current deferred tax assets

   1,228   930

Current deferred tax asset

   1,512   930

Prepaid expenses

   7,792   7,112   7,947   7,112
            

Total current assets

   177,444   178,837   176,412   178,837

Leasehold improvements, property and equipment, net

   426,048   404,740   444,259   404,740

Other assets

   3,193   2,893   3,223   2,893

Goodwill

   19,556   17,738   21,939   17,738
            

Total assets

  $626,241  $604,208  $645,833  $604,208
      
      

Liabilities and shareholders’ equity

        

Current liabilities:

        

Accounts payable

  $19,651  $19,567  $19,923  $19,567

Accrued payroll and benefits

   16,300   16,764   16,116   16,764

Accrued liabilities

   22,810   23,277   20,753   23,277

Current portion of deemed landlord financing

   72   71   74   71

Income tax payable

   7,875   1,522   3,328   1,522
            

Total current liabilities

   66,708   61,201   60,194   61,201

Deferred rent

   49,161   46,222   53,691   46,222

Deemed landlord financing

   4,018   4,036   3,999   4,036

Deferred income tax liability

   17,174   18,681   13,983   18,681

Other liabilities

   3,019   111   3,335   111
            

Total liabilities

   140,080   130,251   135,202   130,251
            

Shareholders’ equity:

        

Preferred stock, $0.01 par value, 600,000 shares authorized, no shares outstanding as of March 31, 2007 and December 31, 2006, respectively

   —     —  

Class A common stock, $0.01 par value, 200,000 shares authorized, 14,245 and 14,222 shares outstanding as of March 31, 2007 and December 31, 2006, respectively

   142   142

Class B common stock, $0.01 par value, 30,000 shares authorized, 18,374 and 18,322 shares outstanding as of March 31, 2007 and December 31, 2006, respectively

   184   183

Preferred stock, $0.01 par value, 600,000 shares authorized, no shares outstanding as of June 30, 2007 and December 31, 2006

   —     —  

Class A common stock, $0.01 par value, 200,000 shares authorized, 14,290 and 14,222 shares outstanding as of June 30, 2007 and December 31, 2006, respectively

   143   142

Class B common stock, $0.01 par value, 30,000 shares authorized, 18,374 and 18,322 shares issued and outstanding as of June 30, 2007 and December 31, 2006, respectively

   184   183

Additional paid-in capital

   473,016   470,653   477,504   470,653

Accumulated other comprehensive income

   7   7   7   7

Retained earnings

   12,812   2,972   32,793   2,972
            

Total shareholders’ equity

   486,161   473,957   510,631   473,957
            

Total liabilities and shareholders’ equity

  $626,241  $604,208  $645,833  $604,208
            

See accompanying notes to consolidated financial statements.

Chipotle Mexican Grill, Inc.

Consolidated Statement of Income

(unaudited)

(in thousands, except per share data)

 

  Three months ended
March 31
   Three months ended June 30, Six months ended June 30, 
  2007 2006   2007 2006 2007 2006 

Revenue:

        

Restaurant sales

  $235,484  $186,411   $274,222  $204,236  $509,706  $390,647 

Franchise royalties and fees

   611   604    124   700   735   1,304 
                    

Total revenue

   236,095   187,015    274,346   204,936   510,441   391,951 
                    

Restaurant operating costs (exclusive of depreciation and amortization shown separately below):

   

Restaurant operating costs:

     

Food, beverage and packaging

   74,671   59,232    87,463   63,341   162,134   122,573 

Labor

   65,454   52,937    71,116   56,941   136,570   109,878 

Occupancy

   17,288   13,872    18,322   14,338   35,610   28,210 

Other operating costs

   29,758   23,238    33,665   25,873   63,423   49,111 

General and administrative expenses

   17,009   15,267    18,109   17,643   35,118   32,910 

Depreciation and amortization

   10,164   8,003    10,576   8,309   20,740   16,312 

Pre-opening costs

   1,810   1,110    2,570   1,505   4,380   2,615 

Loss on disposal of assets

   1,292   623    1,843   1,116   3,135   1,739 
                    
   217,446   174,282    243,664   189,066   461,110   363,348 
                    

Income from operations

   18,649   12,733    30,682   15,870   49,331   28,603 

Interest income

   1,490   970    1,530   1,622   3,020   2,592 

Interest expense

   (75)  (64)   (74)  (65)  (149)  (129)
                    

Income before income taxes

   20,064   13,639    32,138   17,427   52,202   31,066 

Provision for income taxes

   (7,624)  (5,651)   (12,157)  (6,635)  (19,781)  (12,286)
                    

Net income

  $12,440  $7,988   $19,981  $10,792  $32,421  $18,780 
                    

Earnings per share:

   

Earnings per common share:

     

Basic

  $0.38  $0.26   $0.61  $0.33  $0.99  $0.59 
                    

Diluted

  $0.38  $0.26   $0.60  $0.33  $0.98  $0.59 
             
       

Weighted average common shares outstanding:

        

Basic

   32,558   30,683    32,642   32,462   32,600   31,577 
                    

Diluted

   32,953   31,078    33,065   32,903   33,010   31,986 
                    

See accompanying notes to consolidated financial statements.

Chipotle Mexican Grill, Inc.

Consolidated Statement of Cash Flows

(unaudited)

(in thousands)

 

  Three months ended
March 31
   Six months ended June 30, 
  2007 2006   2007 2006 

Operating activities

      

Net income

  $12,440  $7,988   $32,421  $18,780 

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

   10,164   8,003    20,740   16,312 

Current income tax provision

   —     1,832    —     1,832 

Deferred income tax benefit

   (1,805)  (1,185)   (5,280)  (3,679)

Loss on disposal of assets

   1,292   623    3,135   1,739 

Bad debt allowance

   —     138    —     362 

Stock-based compensation

   1,568   1,520    4,052   3,028 

Other

   (81)  —      79   (50)

Changes in operating assets and liabilities:

      

Accounts receivable

   (467)  (978)   (1,405)  (396)

Inventory

   (611)  (424)   (857)  (415)

Prepaid expenses

   (680)  1,632    (835)  1,869 

Other assets

   (300)  (95)   (331)  25 

Accounts payable

   3   (3,570)   962   (1,749)

Accrued liabilities

   (2,862)  (372)   (3,177)  (1,178)

Income tax payable

   8,689   4,601    4,142   4,866 

Due to McDonald’s Corp.

   —     1,714 

Due to (from) McDonald’s Corp.

   —     (288)

Deferred rent

   3,089   1,767    7,769   4,012 

Other long-term liabilities

   308   —   

Other long term liabilities

   624   —   
              

Net cash provided by operating activities

   30,747   23,194    62,039   45,070 
       
       

Investing activities

      

Purchases of leasehold improvements, property and equipment, net

   (32,108)  (14,200)   (62,716)  (37,005)

Franchise acquisitions

   (562)  —      (5,668)  —   
              

Net cash used in investing activities

   (32,670)  (14,200)   (68,384)  (37,005)
              

Financing activities

      

Proceeds from sale of common stock

   —     133,333    —     133,333 

Cost of issuing common stock

   —     (12,400)

Costs of issuing common stock

   —     (12,436)

Proceeds from option exercises

   354   839    1,025   1,384 

Excess tax benefit on stock-based compensation

   446   403    1,529   660 

Payments on deemed landlord financing

   (17)  (14)   (34)  (28)

Proceeds from McDonald’s tax sharing agreement

   6,400   8,757 

Proceeds from McDonald’s—intercompany notes

   6,400   2,248    —     2,248 
              

Net cash provided by financing activities

   7,183   124,409    8,920   133,918 
              

Net change in cash and cash equivalents

   5,260   133,403    2,575   141,983 

Cash and cash equivalents at beginning of period

   153,642   61    153,642   61 
              

Cash and cash equivalents at end of period

  $158,902  $133,464   $156,217  $142,044 
              

Supplemental disclosures of non-cash information

   

Supplemental disclosures of cash flow information

   

Net purchases of leasehold improvements, property and equipment accrued in accounts payable

  $(81) $328   $606  $(279)
              

Franchise acquisition purchase price outstanding as of March 31, 2007

  $1,926  $—   
       

See accompanying notes to consolidated financial statements.

Chipotle Mexican Grill, Inc.

Notes to Consolidated Financial Statements

(unaudited)

(dollar and share amounts in thousands, unless otherwise specified)

1. Basis of Presentation

1.Basis of Presentation

Chipotle Mexican Grill, Inc. (the “Company”), a Delaware corporation, develops and operates fast-casual, fresh Mexican food restaurants with a focused menu of burritos, tacos, burrito bowls and salads in 2628 states throughout the United States and in the District of Columbia. As of March 31,June 30, 2007, the Company operated 605 restaurants and had four restaurants operated by a franchisee.640 restaurants. The Company manages its operations based on three regions and has aggregated its operations to one reportable segment.

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of its financial position and results of operations. Interim results of operations are not necessarily indicative of the results that may be achieved for the full year. The financial statements and related notes do not include all information and footnotes required by U.S. generally accepted accounting principles for annual reports. This quarterly report should be read in conjunction with the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

2. Adoption of New Accounting Principle

2.Adoption of New Accounting Principle

Effective January 1, 2007, the Company adopted Emerging Issue Task Force (“EITF”) Issue No. 06-2,Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43 Accounting for Compensated Absences (“EITF 06-2”). The EITF concluded that sabbatical leave accumulates pursuant to the criteria of Statement of Accounting Standard (“SFAS”) No. 43,Accounting for Compensated Absences (“FAS 43”) and therefore the benefit should be accrued if the remaining criteria of FAS 43 are met. The Company offers sabbatical leave to employees who have provided ten years of service. The actuarially determined accrued sabbatical balance as of December 31, 2006 was $2,600, which the Company recognized as a cumulative-effect accounting adjustment to beginning retained earnings on January 1, 2007. During the three months and six months ended March 31,June 30, 2007, the Company accrued $141sabbatical expense of sabbatical expense.$148 and $289, respectively.

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48,Accounting for Uncertainty in Income Taxes(“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Adoption of FIN 48 did not have an impact on the Company’s consolidated financial statements.

The Company’s policy is to recognize interest to be paid on an underpayment of income taxes in interest expense and any related statutory penalties in provision for income taxes in the consolidated statement of income. The Company is open to federal and state tax audits until the applicable statute of limitations expire. Tax audits by their very nature are often complex and can require several years to complete. The Company is no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2003. For the majority of states where the Company has a significant presence, it is no longer subject to tax examinations by tax authorities for tax years before 2002.

3. Franchise Acquisitions

3.Franchise Acquisitions

On March 7, March 31, and April 30, 2007, the Company acquired two, two and four franchised restaurants.restaurants, respectively. The results of operations have been included in the Company’s financial results from the datedates of acquisition. On March 31, 2007, the Company acquired two additional franchised restaurants. These acquisitions resulted from the franchisees’ obligation under their franchise agreement with McDonald’s Corporation (“McDonald’s”) to dispose of either their Chipotle franchise or their McDonald’s Corporation (McDonald’s) franchise within 24 months after McDonald’s ceased to own a majority of the outstanding common stock of Chipotle, which occurred on October 12, 2006. The acquisitions were accounted for using the purchase method as defined in SFAS No. 141,Business Combinations. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. Goodwill will not be amortized, but instead will be tested for impairment at least annually. The aggregate purchase price of $2,488$5,668 for the foureight restaurants acquired has been allocated as follows:

 

Current assets

  $26 

Net current assets

  $51

Leasehold improvements, property and equipment

   649    1,416

Goodwill

   1,818    4,201

Current liabilities

   (5)
       

Total

  $2,488   $5,668
       

Chipotle Mexican Grill, Inc.

Notes to Consolidated Financial Statements

(unaudited)

(dollar and share amounts in thousands, unless otherwise specified)

4. Stock Based Compensation

4.Stock-based Compensation

In February 2007, the Company issued 275 options to purchase shares of its class A common stock to eligible employees with a grant date fair value of $24.80 per share and an exercise price of $63.89 per share which vest on the third anniversary of the grant date. Compensation expense is generally recognized equally over the three year vesting period. Compensation expense related to employees eligible to retire and retain rights to the awards is recognized over six months which coincides with the notice period. The Company also granted to executive officers 120 shares of non-vested class A common stock with a grant date fair value of $63.89 which vests in two equal installments on the second and third anniversary of the grant. Compensation expense is recognized on a straight-line basis for each separate vesting portion (graded vesting).

Stock-based compensation, including options and non-vested shares,stock, was $1,644$2,576 and $4,220 ($1,0011,569 and $2,570 net of income tax) infor the three months and six months ended March 31,June 30, 2007 respectively, and $1,520was $1,508 and $3,028 ($915908 and $1,823 net of income tax) infor the three months and six months ended March 31, 2006.June 30, 2006, respectively. For the three months and six months ended March 31,June 30, 2007, $76$92 and $168 of stock-based compensation was recognized as capitalized development and is included in leasehold improvements, property and equipment in the consolidated balance sheet. During the threesix months ended March 31,June 30, 2007, 2366 options to purchase class A common sharesstock were exercised, 132 shares of class A common stock were granted to non-employee board members, 23 options were forfeited and 52 shares of class B sharescommon stock vested.

5. Earnings Per Share

5.Earnings Per Share

Basic earnings per share is calculated by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during each period. Diluted earnings per share is calculated using income available to common shareholders divided by diluted weighted-average shares of common stock outstanding during each period. Potentially dilutive securities include potential common shares related to stock options and non-vested stock.

The following table sets forth the computations of basic and dilutive earnings per share:

 

  Three months ended
March 31
  Three months ended June 30,  Six months ended June 30,
  2007  2006  2007  2006  2007  2006

Net income

  $12,440  $7,988  $19,981  $10,792  $32,421  $18,780

Shares:

            

Weighted average number of common shares outstanding

   32,558   30,683   32,642   32,462   32,600   31,577

Dilutive stock options

   352   278   353   356   353   308

Dilutive non-vested stock

   43   117   70   85   57   101
                  

Diluted weighted average number of common shares outstanding

   32,953   31,078

Diluted weighted average number of common shares outstanding.

   33,065   32,903   33,010   31,986
                  

Basic earnings per share

  $0.38  $0.26  $0.61  $0.33  $0.99  $0.59
                  

Diluted earnings per share

  $0.38  $0.26  $0.60  $0.33  $0.98  $0.59
                  

6.6. Commitments and Contingencies

In August 2004, the merchant bank that processes the Company’s credit and debit card transactions informed the Company it may have been the victim of a possible theft of credit and debit card data. During 2004, the Company recorded a reserve for the potential exposure for losses and fines of $4,000. Through June 30, 2007, the Company utilized $2,789 of the reserve to cover fines and losses. In June 2007, the Company determined more than 90% of the possibly-affected cards had expired and the Company had

incurred minimal losses from related claims in the last year. Accordingly, the Company concluded that any remaining exposure was remote and reversed the remaining reserve of $1,211 ($737 net of income tax and $0.02 impact on basic and diluted earnings per share for the three and six months ended June 30, 2007) in general and administrative expenses in the consolidated statement of income. To the extent the Company receives additional claims or incurs fines or legal or other expenses related to this matter, such amounts will be recognized as expense in the consolidated statement of income when incurred.

The Company has become aware of a case filed against us in California alleging violations of state laws regarding employee record-keeping, meal and rest breaks, payment of overtime and related practices with respect to its employees. The case seeks damages, penalties and attorney’s fees on behalf of a purported class of the Company’s present and former employees. The Company is currently investigating these claims, and although it believes it has various defenses it is not possible at this time to reasonably estimate the outcome of or any potential liability from this case.

In the normal course of business, the Company is subject to other proceedings, lawsuits and other claims. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. Consequently, the Company is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters as of March 31,June 30, 2007. These matters could affect the operating results of any one quarter when resolved in future periods. Management does not believe that any monetary liability or financial impact to the Company as a result of currently knownthese proceedings or claims will be material to the Company’s annual consolidated financial statements. However, a significant increase in the number of these claims, or one or more successful claims resulting in greater liabilities than the Company currently anticipates, could materially and adversely affect the Company’s business, financial condition, results of operation or cash flows.

Chipotle Mexican Grill, Inc.

Notes to Consolidated Financial Statements

(unaudited)

(dollar and share amounts in thousands, unless otherwise specified)

In August 2004, the merchant bank that processes the Company’s credit and debit card transactions informed the Company it may have been the victim of a possible theft of credit and debit card data. Together with two forensic auditing firms, the Company investigated the alleged theft and reviewed its information systems and information security procedures. The Company also reported the problem to federal law enforcement authorities and has been cooperating in their investigation. While to date the Company has not discovered conclusive evidence that a theft occurred, the Company has upgraded its information security systems, including remediating the specific problems identified during the forensic audits. During 2004, the Company recorded a reserve for the potential exposure for losses and fines of $4,000. Through March 31, 2007, the Company utilized $2,789 of the reserve to cover fines and losses. As the situation develops and more information becomes available, the amount of the reserve may increase or decrease accordingly.

7. Subsequent Events

On April 30, 2007, the Company acquired the remaining four franchised restaurants at a purchase price of $3,150 plus the inventory value.

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Note Regarding Forward-Looking Statements

Certain statements in this report, including our estimates of the number of restaurants we intend to open as well as projections regardingand potential changes in comparable restaurant sales during 2007 and beyond as well as projections regarding food costs and in the amount of certain expectedlabor expenses, for 2007, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. We use words such as “anticipate”, “believe”, “could”, “should”, “estimate”, “expect”, “intend”, “may”, “predict”, “project”, “target”, and similar terms and phrases, including references to assumptions, to identify forward-looking statements. These forward-looking statements are based on information available to us as of the date any such statements are made, and we assume no obligation to update these forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those described in the statements. These risks and uncertainties include, but are not limited to, the risk factors described in our annual report on Form 10-K for the year ended December 31, 2005.2006.

Overview

Chipotle develops and operates fast casual, fresh Mexican food restaurants serving burritos, tacos, burrito bowls (a burrito without the tortilla) and salads. We began with a simple philosophy: demonstrate that food served fast doesn’t have to be a traditional “fast-food”“fast food” experience. Over the years, that vision has evolved. Today, we’re working to change the way people think about and eat fast food. We do this by avoiding a formulaic approach when creating our restaurant experience, looking to fine-dining restaurants for inspiration. We use high-quality raw ingredients, classic cooking methods and a distinctive interior design, and have friendly people to take care of each customer—features that are more frequently found in the world of fine dining.fine-dining. Our approach is also guided by our belief in an ideavision called “Food With Integrity”. Our approach is also guided by a vision we call “Food With Integrity”— which. Our objective is to us means findingfind the very best raw ingredients we can – ingredients that are grown or raised with respect for the environment, animals and people who grow or raise the food. For example, we seek to serve meat from the best sources to include in the food we serve. Quite simply, we combine these ideas inanimals that are humanely-raised, without added hormones or antibiotics and are fed a way that continues making Chipotle better all the time.vegetarian diet.

2007 Highlights

Restaurant Development. As of March 31,June 30, 2007, we had 609640 restaurants in 2628 states throughout the United States and in the District of Columbia, including four restaurants operated by a franchisee.Columbia. New restaurants have contributed substantially to our restaurant sales growth. We opened 28 company-operated32 and 60 restaurants during the three months and six months ended March 31,June 30, 2007. We expect to open between 110 and 120 total restaurants in 2007.

Sales Growth.In addition to growing our number of restaurants, we have experienced increases in our average restaurant sales from $1.502$1.545 million as of March 31,June 30, 2006 to $1.631$1.674 million as of March 31,June 30, 2007, driven primarily by strong comparable restaurant sales increases. ComparableOur comparable restaurant sales reflect positive period-to-period growth due mainly to an increase inincreases for the numberfirst six months of transactions processed at our registers.2007 were 10.0%. We define average restaurant sales as the average trailing 12-month sales for company-ownedcompany-operated restaurants in operation for at least 1312 full calendar months. Comparable restaurant sales include company-owned restaurants only and represent the change in period-over-period sales for restaurants beginning in their 13th full calendar month of operation.operation. Comparable restaurant sales increases were due mainly to an increase in the number of transactions processed at our registers, menu price increases and improved restaurant–level controls. We expect our average restaurant sales to continue to increase in 2007, driven by comparable restaurant sales increases in the mid-to-highhigh single digits. Our comparable restaurant sales increasedigits to low double digits for the first quarter of 2007 was 8.3%. As a result of nine years of double-digit comparable restaurant sales increases, we believe that comparable restaurant sales likely will not continue to increase at the rates we have achieved over the past several years.full year.

Food Costs.We expect cost pressures to continue in the second and third quartersquarter of 2007 as a result of the winter freeze in California and the southwestern U.S., which impacted citrus and avocado crops. Additionally, due to increased demand for ethanol the cost of corn has increased substantially, which has increased the cost of corn-sourced ingredients as well as wheat, soybeans and rice. We expect this will leadThis has led to upward pricing pressures on many of our raw ingredients including chicken, beef and pork.pork and we expect that pressure to continue for the remainder of 2007 and into 2008.

Labor.Labor costs as a percentage of revenue decreased in the first half of 2007 primarily due to improved employee efficiency and more effective management of staffing, improved employee efficiency as average restaurant sales increased faster than our need to add labor and lower insurance claims experience benefiting us as we became self-insured in the fourth quarter of 2006. The decrease was partially offset by continued incremental staffing costs as we transition to our newan increase in hourly employee wages in part from the Restaurateur program and the restaurant structure described below.introduced in 2006. Although we have not been directly impacted by recent minimum wage increases, we anticipate some upward pressure on our restaurant wages in the remainder of 2007 and 2008.

We continue to focus on ensuring our employee practices are as exceptional as our food. In order to achieve this, we initiated

the Restaurateur program in early 2006. The Restaurateur program is designed to encourage the restaurant manager position as a career opportunity for our top performing managers. In addition to excelling in providing quality food and customer service, restaurant

managers are expected to contribute substantially to the development of their crew. We also launched a new restaurant management structure in the second quarter of 2006 to facilitate the development of crew members into restaurant managers. OneOur primary goal of the new restaurant structure is to increase the number of restaurant managers hired from within our company and lower restaurant turnover. While still early in both programs, weWe continue to see positive results through increased internal promotions and decreased turnover.

Food With Integrity.DuringIn addition to continuing to serve naturally-raised pork in all of our restaurants, during the first quarterhalf of 2007, we made progress on delivering Food With Integrity by increasing the amountnumber of naturally raisedour restaurants serving naturally-raised beef and chicken. We now serve naturally-raised chicken served in our restaurants. In addition, in all73% of our restaurants and naturally-raised beef in 46%. We are working with suppliers to buy cheese made with milk that comes from cows that are not given rBGH, or recombinant bovine growth hormone, to stimulate milk production. All of the sour cream we now use unbleached napkins madebuy comes from 90% post-consumer recycled paper.cows that have not been treated with rBGH. We also continue to investigate the use of more sustainably grown produce and produce that is locally grown.

Throughput. We deliver our best customer service and hottest food when the line moves efficiently. Through implementation and execution of our new restaurant structure, we continue to increase the number of customers we serve during our busiest hours. In addition change machines were installed in approximately 400 restaurants duringby the first quarter of 2007, change machines had been installed in virtually all of our restaurants, and we continue to review other equipment configurations, technological process improvementstechnology and kitchen design modifications to improve the speed of service.

Franchise Acquisitions.In March 2007, we completed the acquisition of four franchised restaurants from two franchisees for an aggregate purchase price of $2.5 million. The remaining four franchised restaurants were acquired on April 30, 2007 for a purchase price of $3.2 million.

Commitments and Contingencies. In June 2007, after determining the reserve for claims seeking reimbursement for purportedly fraudulent credit and debit card transactions and related costs was no longer needed, we reversed the remaining $1.2 million reserve into income. See Note 6 to the Consolidated Financial Statements included in Part I, Item 1.

Restaurant Activity

The following table details restaurant unit data for our company-owned and franchised locations for the yearsperiods indicated.

 

  

For the three months

ended March 31

  For the three months
ended June 30
  For the six months
ended June 30
  2007 2006  2007 2006  2007 2006

Company-operated

         

Beginning of period

  573  481  605  496  573  481

Openings

  28  15  32  14  60  29

Closures

  (1) —    (1) —  

Franchise acquisitions

  4  —    4  —    8  —  
                  

End of period

  605  496  640  510  640  510
      

Franchises

         

Beginning of period

  8  8  4  8  8  8

Franchise acquisitions

  (4) —    (4) —    (8) —  
                  

End of period

  4  8  —    8  —    8
                  

Total restaurants at end of period

  609  504  640  518  640  518
                  

Results of Operations

Our results of operations as a percentage of revenue and period-over-period variances are discussed in the following section. As our business grows, as we open more stores and hire more employees, our restaurant operating costs increase.

Restaurant Sales

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Restaurant sales

  $235.5  $186.4  26.3%  $274,222  $204,236  34.3% $509,706  $390,647  30.5%

Average restaurant sales

  $1.631  $1.502    $1,674  $1,545  8.3% $1,674  $1,545  8.3%

Comparable restaurant sales increases

   8.3%  19.7%    11.6%  14.5%   10.0%  16.9% 

Number of company-operated restaurants as of the end of the period

   605   496     640   510  25.5%  640   510  25.5%

Number of company-operated restaurants opened in the period

   28   15     32   14    60   29  

The significant factors contributing to our increase in sales for the first quarter ofthree and six months ended June 30, 2007 were restaurant openings and strong comparable restaurant sales performance. Restaurant sales for the three and six months ended June 30, 2007 for restaurants not in the comparable restaurant base contributed to $34.0$43.4 million and $77.5 million of the increase in sales, respectively, of which $6.0$15.6 million and $21.7 million was attributable to restaurants opened in 2007. Comparable restaurant sales increases contributed to $15.1$26.6 million of the increase in restaurant sales for the second quarter of 2007, and $41.6 million of the increase in restaurant sales for the first half of 2007. Comparable restaurant sales increases were driven primarily by an increasing awareness of our brand, increased customer loyalty and our focus on improving service time. The substantial majority of our comparable restaurant sales growth was due to an increase in the number of transactions, and the remainder was driven primarily by menu price increases in selected markets in conjunction with the introduction of naturally-raised beef or chicken.chicken, as well as improved restaurant-level controls.

Food, Beverage and Packaging Costs

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Food, beverage and packaging

  $74.7  $59.2  26.1%  $87,436  $63,341  38.1% $162,134  $122,573  32.3%

As a percentage of revenue

   31.6%  31.7%    31.9%  30.9%   31.8%  31.3% 

As a percentage of revenue, food, beverage and packaging costs decreasedincreased due primarily to an improvement in food controls andincreased product costs partially offset by menu price increases in selected markets in conjunction with the introduction of naturally-raised beef or chicken, partially offset by increased product costs.as well as an improvement in food controls.

Labor Costs

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Labor costs

  $65.5  $52.9  23.6%  $71,116  $56,941  24.9% $136,750  $109,878  24.3%

As a percentage of revenue

   27.7%  28.3%    25.9%  27.8%   26.8%  28.0% 

Labor costs as a percentage of revenue decreased in 2007 primarily due to improved employee efficiency and more effective management of staffing, improved employee efficiency as average restaurant sales increased faster than our need to add labor and lower insurance claims experience benefiting us as we became self-insured in the fourth quarter of 2006. The decrease was partially offset by an increase in hourly employee wages and continued incremental staffing costs as we transition to our new restaurant structure. We launched the new restaurant management structure to develop a defined path for crew to become restaurant managers enabling more promotions from within which should lower turnover, result in better managers and decrease training costs.wages.

Occupancy Costs

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Occupancy costs

  $17.3  $13.9  24.6%  $18,322  $14,338  27.8% $35,610  $28,210  26.2%

As a percentage of revenue

   7.3%  7.4%    6.7%  7.0%   7.0%  7.2% 

In 2007, occupancy costs decreased as a percentage of revenue due to higher average restaurant sales on a partially fixed-cost base, partially offset by higher rents for new locations and the opening of restaurants in more expensive locations such as New York City and the San Francisco Bay area.locations.

Other Operating Costs

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Other operating costs

  $29.8  $23.2  28.1%  $33,665  $25,873  30.1% $63,423  $49,111  29.1%

As a percentage of revenue

   12.6%  12.4%    12.3%  12.6%   12.4%  12.5% 

Other operating costs as a percentage of revenue increaseddecreased in the second quarter of 2007 primarily due ourto higher average restaurant sales on a partially fixed cost base.

For the first half of 2007 the decrease as a percentage of revenue was due to the effect of higher average restaurant sales on a partially fixed cost base, partially offset by increased marketing and promotion spend in the first quarter of 2007. This increase was partially offset from the realization of a benefit in 2007 related to our promote from within strategy which reduced the dollars we spend on training external hires.spend. We expect the marketing and promotion spend as a percentage of revenue for the full year 2007 will remain consistent with 2006.

General and Administrative Expenses

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

General and administrative expense

  $17.0  $15.3  11.4%  $18,109  $17,643  2.6% $35,118  $32,910  6.7%

As a percentage of revenue

   7.2%  8.2%    6.6%  8.6%   6.9%  8.4% 

The increase in general and administrative expenses in 2007 primarily resulted from hiring more employees as we grew. grew and an increase in stock-based compensation expense resulting from the stock-based compensation awards granted in February 2007. The increase was partially offset by the reversal of the credit card contingency reserve in the second quarter of 2007 and costs incurred for severance and a secondary offering of our common stock in the second quarter of 2006.

As a percentage of total revenue, general and administrative expenses decreased due to the effect of higher restaurant sales on a partially fixed-cost base. We expect general and administrative expenses to increase inbase, the remainderreversal of the credit card contingency benefiting the second quarter of 2007 primarily due to stock-based compensation awards granted in February 2007.and the costs incurred for severance and the secondary offering negatively impacting the second quarter of 2006.

Depreciation and amortization

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Depreciation and amortization

  $10.2  $8.0  27.0%  $10,576  $8,309  27.3% $20,740  $16,312  27.1%

As a percentage of revenue

   4.3%  4.3%    3.9%  4.1%   4.1%  4.2% 

Depreciation and amortization increased in 2007 primarily due to restaurants opened in 2006 and 2007. As a percentage of total revenue, depreciation and amortization has remained consistentdecreased as a result of higher average restaurant sales on a partially fixed-cost base, offset by accelerated depreciation on our corporate office and certain identified restaurants.

Pre-opening costs

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Pre-opening costs

  $1.8  $1.1  63.1%  $2,570  $1,505  70.8% $4,380  $2,615  67.5%

As a percentage of revenue

   0.8%  0.6%    0.9%  0.7%   0.9%  0.7% 

Restaurant openings

   32   14    60   29  

The increase in pre-opening costs is a result of an increase in the number of restaurant openings from 15 during the first quarter of 2006 to 28 in the first quarter of 2007.

Loss on Disposal of Assets

 

   For the three
months ended
March 31
  

%

increase

   2007  2006  
   (dollars in millions)

Loss on disposal of assets

  $1.3  $0.6  *

As a percentage of revenue

   0.5%  0.3% 

*not meaningful
   For the three months
ended June 30
  %  For the six months
ended June 30
  % 
    2007  2006  increase  2007  2006  increase 
   (dollars in thousands) 

Loss on disposal of assets

  $1,843  $1,116  65.1% $3,135  $1,739  80.3%

As a percentage of revenue

   0.7%  0.5%   0.6%  0.4% 

The increase in loss on disposal of assets was due to an increase in asset retirements due to increase in both the age and number of restaurants, a pending closurethe upgrade of one restaurant due to a city redevelopment projectsecurity systems and an increase in the write-offs associated with investigating potential storerestaurant sites that we considered but subsequently rejected.

Interest Income

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 decrease 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Interest income

  $1.5  $1.0  53.6%  $1,530  $1,622  (5.7)% $3,020  $2,592  16.5%

As a percentage of revenue

   0.6%  0.5%    0.6%  0.8%   0.6%  0.7% 

Interest income resulted from investing our incremental cash and cash equivalents in short-term investments with maturities of three months or less. The incremental cash and cash equivalents resultedFor the three months ended June 30, 2007 interest income decreased primarily due to an increase in investments in tax-exempt securities which have lower interest rates but are exempt from our initial public offering proceeds and cash from operations. The increase isfederal income taxes.

For the six months ended June 30, 2007 interest income increased due to a higher daily average cash equivalent balance in the first quarterhalf of 2007 compared to the same period in 2006.2006 partially offset by an increase in investments in tax-exempt securities.

Provision for Income Taxes

 

  For the three
months ended
March 31
 

%

increase

   For the three months
ended June 30
 % For the six months
ended June 30
 % 
  2007 2006   2007 2006 increase 2007 2006 increase 
  (dollars in millions)   (dollars in thousands) 

Provision for income taxes

  $(7.6) $(5.7) 34.9%  $12,157  $6,635  83.2% $19,781  $12,286  61.0%

As a percentage of revenue

   (3.2)%  (3.0)%    4.4%  3.2%   3.9%  3.1% 

Effective tax rate

   38.0%  41.4%    37.8%  38.1%   37.9%  39.5% 

The decrease in the effective tax rate was primarily due to investments in tax-exempt securities the 2006 tax rate including the impact of disallowed compensation expense and a decrease in the estimated statutory state tax rate. Additionally during the second quarter of 2006, we revised our estimated 2006 annual effective tax rate to 40.0% from 41.4% due to the utilization of excess tax benefits on stock-based compensation and adjusted our deferred tax assets and liabilities for enacted changes in state tax laws which resulted in a benefit to the effective tax rate. The changes in state tax laws enacted in 2007 had no measurable impact on the effective tax rate.

Seasonality

Seasonal factors cause our profitability to fluctuate from quarter to quarter. Historically, sales at our restaurant salesrestaurants are lower in the first and fourth quarters due, in part, to the holiday season and because fewer people eat out during periods of inclement weather (the winter months) than during periods of mild or warm weather (the spring, summer and fall months). Other factors also have a seasonal effect on our results. For example, restaurants located near colleges and universities generally do more business during the academic year. The number of trading days can also affect our results. Overall, on an annual basis, changes in trading days do not have a significant impact on our results.

Our quarterly results are also affected by other factors such as the number of new restaurants opened in a quarter and unanticipated events. New restaurants have lower margins following opening as a result of the expenses associated with opening new restaurants and their operating inefficiencies in the months immediately following opening. Because we have tended to open more new restaurants later in the fiscal year, our fourth quarter net income has historically been lower than other quarters. However, we expect restaurant openings to be relatively level-loaded through all four quarters of 2007. In addition, unanticipated events also impact our results. For example, in the second quarter of 2007, after determining the reserve for claims seeking reimbursement for purportedly fraudulent credit and debit card transactions and related costs was no longer needed, we reversed the remaining $1.2 million reserve into income. Accordingly, results for a particular quarter are not necessarily indicative of results to be expected for any other quarter or for any year.

Liquidity and Capital Resources

Our primary liquidity and capital requirements are for new restaurant construction, working capital and general corporate needs. We haven’t required significant working capital because customers pay using cash or credit cards and because our operations do not require significant receivables, nor do they require significant inventories due, in part, to our use of various fresh ingredients. In addition, we generally have the right to pay for the purchase of food, beverage and supplies some time after the receipt of those items, generally within ten days, thereby reducing the need for incremental working capital to support growth.

Operating Activities. Net cash provided by operating activities was $30.7$62.0 million for the threesix months ended March 31,June 30, 2007 compared to $23.2$45.1 million for the same period in 2006. The $7.5$16.9 million increase was primarily attributable to a $4.5$13.6 million improvement in net income and a change in operating assets and liabilities.

Investing Activities. Net cash used in investing activities was $32.7$68.4 million for the threesix months ended March 31,June 30, 2007 compared to $14.2$37.0 million for the same period in 2006. The $18.5$31.4 million increase was primarily attributable to higher capital expenditures in 2007 as we opened 2860 restaurants, compared with 1529 restaurants in 2006, and to increased reinvestment costs as the number of our restaurants and the average restaurant age increases.

Financing Activities. Net cash provided by financing activities was $7.2$8.9 million for the threesix months ended March 31,June 30, 2007 compared to $124.4$133.9 million for the same period in 2006. The $117.2$125.0 million decrease was primarily attributable to the net proceeds received from our initial public offering in 2006.

Liquidity and Capital Expenditures. We will continue to use our available cash balances to provide additional long-term capital to support the growth of our business (primarily through opening restaurants) and to continue to maintain our existing restaurants and for general corporate purposes.

We believe that cash from operations, together with the net proceeds from our initial public offeringcash and cash equivalents on hand will be enough to meet ongoing capital expenditures, working capital requirements and other cash needs over at least the next 24 months.

Off-Balance Sheet Arrangements

As of March 31,June 30, 2007 and December 31, 2006, we had no off-balance sheet arrangements or obligations.

Critical Accounting Estimates

Critical accounting estimates are those that we believe are both significant and that require us to make difficult, subjective or complex judgments, often because we need to estimate the effect of inherently uncertain matters. We base our estimates and judgments on historical experiences and various other factors that we believe to be appropriate under the circumstances. Actual results may differ from these estimates, and we might obtain different estimates if we used different assumptions or conditions. We had no significant changes in our critical accounting estimates since our last annual report.report, except for the release of the remaining $1.2 million reserve we had established relating to the possible theft of customers’ credit and debt card data. Our critical accounting estimates are contained in our annual report on Form 10-K for the year ended December 31, 2006.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSUREDISCLOSURES ABOUT MARKET RISK

Changing Interest Rates

We’re exposed to interest rate risk through the investment of our cash and cash equivalents. Since the completion of our initial public offering we have invested our cash in short-term investments with maturities of three months or less. Changes in interest rates affect the interest income we earn, and therefore impact our cash flows and results of operations. As of March 31,June 30, 2007, we had $153.4$151.9 million deposited in short-term investments bearing a weighted-average interest rate of 4.1%4.0% (approximately 5.6%5.7% tax equivalent).

Commodity Price Risks

We’re also exposed to commodity price risks. Many of the ingredients we use to prepare our food, as well as our packaging materials, are commodities that are affected by demand, weather, seasonality, production, availability and other factors outside our control. We work closely with our suppliers and use a mix of forward pricing protocols under which we agree with our supplier on fixed prices for deliveries at sometime in the future, fixed pricing protocols under which we agree on a fixed price with our supplier for the duration of that protocol, and formula pricing protocols under which the prices we pay are based on specified formula related to the prices of the goods, such as spot prices. Though we generally do not have long-termwritten supply contracts or guaranteed purchase amounts, our pricing protocols with suppliers can remain in effect for periods ranging from one month to a year, depending on the outlook for prices of the particular ingredient. We also sometimes buy supplies at current market or spot prices. We’ve tried to increase, where necessary, the number of suppliers for our ingredients, which we believe can help mitigate pricing volatility, and we follow industry news, trade issues, weather, crises and other world events that may affect supply prices. Long-term increases in ingredient prices could adversely affect our future results if we could not increase menu prices at the same pace for competitive or other reasons. Similarly, if we believe the ingredient price increase to be short in duration we may choose not to pass on the cost increases, which could adversely affect our short-term financial results.

 

ITEM 4.CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, President and Chief Operating Officer and Chief Finance and Development Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of March 31,June 30, 2007, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, President and Chief Operating Officer and Chief Finance and Development Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer, President and Chief Operating Officer and Chief Finance and Development Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annualquarterly report.

There were no changes during the three months ended March 31,June 30, 2007 in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II

 

ITEM 1.LEGAL PROCEEDINGS

During the second quarter of 2007, we reversed the remaining $1.2 million reserve we had established relating to the possible theft of our customers’ credit and debit card data. See Note 6 to the Consolidated Financial Statements included in Part I, Item 1.

We have become aware of a case filed against us in California alleging violations of state laws regarding employee record-keeping, meal and rest breaks, payment of overtime and related practices with respect to our employees. The case seeks damages, penalties and attorney’s fees on behalf of a purported class of our present and former employees. We are currently investigating these claims, and although we believe we have various defenses it is not possible at this time to reasonably estimate the outcome of or any potential liability from this case.

We’re involved in various other claims and legal actions that arise in the ordinary course of business. We do not believe that the ultimate resolution of these actions will have a material adverse effect on our financial position, results of operations, liquidity or capital resources. However, a significant increase in the number of these claims, or one oreor more successful claims under which we incur greater liabilities than we currently anticipate could materially and adversely affect our business, financial condition, results of operation and cash flows.

In addition, we’re involved in claims relating to the possible theft of our customers’ credit and debit card data. Through the end of March 2007, we have received claims through the acquiring bank with respect to fewer than 2,000 purportedly fraudulent credit and debit card charges allegedly arising out of this matter in an aggregate amount of about $1.4 million. We’ve also incurred $1.3 million of expense in connection with fines imposed by the Visa and MasterCard card associations on the acquiring bank. In 2004, we recorded charges of $4.0 million to establish a reserve for claims seeking reimbursement for purportedly fraudulent credit

and debit card charges, the cost of replacing cards, monitoring expenses and fees, and fines imposed by Visa and MasterCard. All of the reimbursement claims are being disputed, although we’ve not formally protested all of the charges. As of March 31, 2007, after charging these expenses against the reserve, the remaining reserve was $1.2 million. In addition to the reserve, we’ve also incurred about $1.5 million of additional expenses in this matter, including $1.4 million for legal fees, bringing our total expense relating to this matter to $5.5 million. We have not reserved any additional amounts to date in 2007.

We may in the future become subject to additional claims for purportedly fraudulent transactions arising out of this matter. We have no way to predict the level of claims or the number or nature of proceedings that may be asserted against us, nor can we quantify the costs that we may incur in connection with investigating, responding to and defending any of them. If we litigate these matters, we may not be able to defend against penalties successfully. The ultimate outcome of this matter could differ materially from the amounts we’ve recorded in our reserve and could have a material adverse effect on our financial results and condition.

ITEM 1A.ITEM 1A.RISK FACTORS

There have been no materialThe following discusses significant changes in our risk factors since our last annual report. You should read this in conjunction with our risk factors in Item 1A in our annual report on Form 10-K for the year ended December 31, 2006.2006

Governmental regulation may adversely affect our ability to open new restaurants or otherwise adversely affect our existing and future operations and results.

We are subject to various federal, state and local regulations. Each of our restaurants is subject to state and local licensing and regulation by health, alcoholic beverage, sanitation, food and workplace safety and other agencies. We may experience material difficulties or failures in obtaining the necessary licenses or approvals for new restaurants, which could delay planned restaurant openings. In addition, stringent and varied requirements of local regulators with respect to zoning, land use and environmental factors could delay or prevent development of new restaurants in particular locations.

We are subject to the U.S. Americans with Disabilities Act and similar state laws that give civil rights protections to individuals with disabilities in the context of employment, public accommodations and other areas. We may in the future have to modify restaurants, for example by adding access ramps or redesigning certain architectural fixtures, to provide service to or make reasonable accommodations for disabled persons. The expenses associated with these modifications could be material.

Our operations are also subject to the U.S. Fair Labor Standards Act, which governs such matters as minimum wages, overtime and other working conditions, along with the U.S. Americans with Disabilities Act, family leave mandates and a variety of similar laws enacted by the states that govern these and other employment law matters. We have become aware of a case filed against us in California alleging violations of state laws regarding employee record-keeping, meal and rest breaks, payment of overtime and related practices with respect to our employees. We could suffer losses in this case or similar cases, and any such losses could be significant. In addition, several states in which we operate and the federal government have recently enacted minimum wage increases, and these increases could increase our labor costs.

In recent years, there has been an increased legislative, regulatory and consumer focus at the federal, state and municipal levels on the food industry including nutrition and advertising practices. Restaurants operating in the quick-service and fast-casual segments have been a particular focus. For example, the New York City Board of Health has adopted a regulation requiring that restaurants that make calorie information publicly available must include that information on their menus and menu boards. We may in the future become subject to other initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of our food, which could increase our expenses.

We are subject to federal, state and local environmental laws and regulations concerning the discharge, storage, handling, release and disposal of hazardous or toxic substances, as well as local ordinances restricting the types of packaging we can use in our restaurants. Many environmental laws applicable to us provide for significant fines, penalties and liabilities, sometimes without regard to whether we knew of, or were responsible for, the release or presence of hazardous or toxic substances. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of, or actual or alleged exposure to, such substances. We cannot predict what environmental laws will be enacted in the future, how existing or future environmental laws will be administered or interpreted, or the amount of future expenditures that we may need to make to comply with, or to satisfy claims relating to, environmental laws. We have not conducted a comprehensive environmental review of our properties or operations. We have, however, conducted investigations of some of our properties and identified contamination caused by third-party operations. We believe any such contamination has been or should be addressed by the third party. If the relevant third party does not address or has not addressed the identified contamination properly or completely, then under certain environmental laws, we could be held liable as an owner and operator to address any remaining contamination. Any such liability could be material. Further, we may not have identified all of the potential environmental liabilities at our properties, and any such liabilities could have a material adverse effect on our operations or results of operations.

 

ITEM 3.ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Recent Sales of Unregistered Securities and Use of Proceeds from Sale of Registered Securities

On January 30, 2006, we completed the initial public offering of our Class A common stock, $0.01 par value, pursuant to our Registration Statement on Form S-1, as amended (Reg. No. 333-129221) that was declared effective on January 25, 2006. We sold 6,060,606 shares in the offering at a price to the public of $22.00 per share. The managing underwriters in the offering were Morgan Stanley and SG Cowen & Co.

The net proceeds received by us in the offering were $120.9 million, determined as follows (in millions):None.

 

Aggregate offering proceeds to the Company

  $133.3

Underwriting discounts and commissions

   9.3

Finders fee

   —  

Other fees and expenses

   3.1
    

Total expenses

   12.4
    

Net proceeds to the Company

  $120.9
    
ITEM 3.DEFAULTS UPON SENIOR SECURITIES

None of the underwriting discounts and commissions or offering expenses were paid, directly or indirectly, to our directors or officers or their associates or to persons owning 10% or more of our common stock or to any affiliates of ours. We used the net proceeds of the offering to provide additional long-term capital to support the growth of our business (primarily through opening new restaurants), for maintenance of our existing restaurants and for general corporate purposes.None.

 

ITEM 4.ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.We held our Annual Meeting of Shareholders on June 13, 2007. At the Annual Meeting, our shareholders voted on the election of three incumbent directors to our Board of Directors, and on the ratification of the appointment of Ernst & Young LLP as our independent registered public accounting firm for 2007. Following are the results of the matters voted on at the Annual Meeting:

(1) In the election of directors, each nominee was elected by a vote of the shareholders as follows:

 

Director (Term Expiring)

  

FOR

  

WITHHELD

Albert S. Baldocchi (2010)

  179,861,750  408,413

Neil W. Flanzraich (2010)

  179,826,209  443,954

Darlene J. Friedman (2010)

  179,620,236  649,817

Additional directors, whose terms of office as directors continued after the Annual Meeting of Shareholders, are as follows:

Term Expiring in 2008

Term Expiring in 2009

John S. Charlesworth

Steve Ells

Montgomery F. Moran

Patrick J. Flynn

(2) The proposal to approve the appointment of Ernst & Young LLP as our independent registered public accounting firm for 2007 was approved by shareholders as follows:

FOR

  

AGAINST

  

ABSTAIN

179,693,588

  556,923  19,652

ITEM 5.ITEM 5.OTHER INFORMATION

None.

 

ITEM 6.EXHIBITS

The exhibits listed in the exhibit index following the signature page are furnished as part of this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

CHIPOTLE MEXICAN GRILL, INC.
By: 

/s/ JOHN R. HARTUNG

Name: John R. Hartung
Title: Chief Finance and Development Officer

Date: May 1,July 31, 2007

Exhibit Index

 

Exhibit

Number

  

Description of Exhibit

  3.1  Restated Certificate of Incorporation of Chipotle Mexican Grill, Inc.*
  3.2  Restated Bylaws of Chipotle Mexican Grill, Inc.*
  4.1  Form of Stock Certificate for Class A Common Stock.*
  4.2  Form of Stock Certificate for Class B Common Stock.**
10.1  Summary of Director Compensation.
10.2Form of Indemnification Agreement betweenAmendment No. 1 to Chipotle Mexican Grill, Inc. and each executive officer and director of Chipotle.***Supplemental Deferred Investment Plan.
31.1  Certification of Chief Executive Officer of Chipotle Mexican Grill, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2  Certification of Chief Finance and Development Officer of Chipotle Mexican Grill, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.3  Certification of President and Chief Operating Officer of Chipotle Mexican Grill, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1  Certification of Chief Executive Officer, Chief Finance and Development Officer and President and Chief Operating Officer of Chipotle Mexican Grill, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*Incorporated by reference to Chipotle Mexican Grill, Inc.’s annual report on Form 10-K for the year ended December 31, 2005 (File No. 001-32731).
**Incorporated by reference to Chipotle Mexican Grill, Inc.’s quarterly report on Form 10-Q for the three months ended September 30, 2006 (File No. 001-32731).
***Incorporated by reference to Chipotle Mexican Grill, Inc.’s current report on Form 8-K filed on March 21, 2007 (File No. 001-32731).

 

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