Notes to Condensed Consolidated Financial Statements
(unaudited)
(dollar and share amounts in thousands, unless otherwise specified)
1. Basis of Presentation
In this quarterly report on Form 10-Q, Chipotle Mexican Grill, Inc., a Delaware corporation, together with its subsidiaries, is collectively referred to as “Chipotle,” “we,” “us,” or “our.”
We develop and operate
restaurants
that serve a focused menu of burritos, tacos, burrito bowls, and salads, made using fresh, high-quality ingredients
. As of
June 30
, 201
7
,
we
operated
2,295
Chipotle restauran
ts throughout the United States as well as
36
international
Chipotle restau
rants and
8
non-Chipotle restaurants. We managed our operations based on
11
regions during the
second
quarter
of
201
7 and have aggregated our
operations to
one
reportable segment.
We have prepared t
he accompanying unaudited condensed consolidated financial statements
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 condensed consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessar
y for a fair presentation of our
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
our
annual report on Form 10-K for the year ended December 31, 201
6
.
2. Recent
Accounting Standards
Recently Issued Accounting Standards
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842).” The pronouncement requires lessees to recognize a liability for lease obligations, which represent the discounted obligation to make future minimum lease payments, and a corresponding right-of-use asset on the balance sheet. The guidance requires disclosure of key information about leasing arrangements which are intended to give financial statement users the ability to assess the amount, timing, and potential uncertainty of cash flows related to leases. This pronouncement is effective for reporting periods beginning after December 15, 2018
,
using a modifie
d retrospective adoption method, with optional practical expedients
. We are currently evaluating the provisions of the new lease standard, and have concluded that the adoption of ASU 2016-02 will have a significant impact on our consolidated balance sheet because we will record material assets and obligations for current operating leases. We are still assessing the expected impact on our consolidated statement of operations.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” as amended by multiple standards updates. This guidance requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, this guidance will require
us to enhance our
disclosures, including
disclosing
performance obligations to customers arising from gift cards and certain promotional activity. The pronouncement is effective for reporting periods beginning after December 15, 2017. The adoption is not expected to have an impact on our consolidated financial position or results of operations.
We reviewed all other recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact on the consolidated financial statements.
Recently Adopted Accounting Standards
In March 2016, the FASB issued ASU 2016-09, “Compensation-Stock Compensation (Topic 718).” The pronouncement was issued to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows.
The Company adopted ASU 2016-09 on January 1, 2017, prospectively (prior periods have not been restated). The primary impact of adoption was the recognition during the three and six months ended June 30, 2017, of $422 and $664, respectively, of excess tax benefits as a reduction to the provision for income taxes, and the classification of these excess tax benefits in operating activities in the consolidated statement of cash flows instead of financing activities.
The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented in the consolidated statement of cash flows, since such cash flows have historically been presented in financing activities. The Company also elected to continue estimating forfeitures when determining the amount of stock-based compensation costs to be recognized in each period. No other provisions of ASU 2016-09 had a material impact on the Company’s financial statements or disclosures.
3. Fair Value of Financial Instruments
The carrying
value of
our
cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of their short-term nature. Investments are carried at fair market value and are classified as available-for-sale. Investments consist of U.S. treasury notes with maturities up to approximately
9
months.
Fair value
of investments
is measured using Level 1 inputs (quoted prices for identical assets in active markets).
The following is a summary of available-for-sale securities:
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|
|
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
2017
|
|
2016
|
Amortized cost
|
$
|
395,055
|
|
$
|
455,109
|
Unrealized gains (losses)
|
|
(589)
|
|
|
(218)
|
Fair market value
|
$
|
394,466
|
|
$
|
454,891
|
The following is a summary of unrealized gains (losses) on available-for-sale securities recorded in other comprehensive income (loss) in the condensed consolidated statement of operations and comprehensive income:
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|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Unrealized gains (losses) on available-for-sale securities
|
$
|
(95)
|
|
$
|
857
|
|
$
|
(371)
|
|
$
|
3,933
|
Unrealized gains (losses) on available-for-sale securities, net of tax
|
$
|
(58)
|
|
$
|
509
|
|
$
|
(240)
|
|
$
|
2,402
|
Realized gains and losses on available-for-sale securities are recorded in interest and other income, net on the condensed consolidated statement of operations and comprehensive income. We had
no
realized gains or losses for the three and six months ended June 30, 2017 and we had
$0
and
$547
of realized gains on available-for-sale securities for the three and six months ended June 30, 2016.
We
also maintain a rabbi trust to fund obligations under a deferred compensation plan. Amounts in the rabbi trust are invested in mutual funds, which are designated as trading securities and carried at fair value, and are included in other assets in the
condensed
consolidated balance sheet. Fair market value of mutual funds is measured using Level 1 inputs. The fair value of the investments in the rabbi trust was $
18,516
and $
17,843
as of
June 30
, 201
7
and December 31, 201
6
, respectively.
We record
trading gains and losses in general and administrative expenses in the
condensed
consolidated statement of operations and comprehensive income
, along with the offsetting amount related to the increase or decrease in defe
rred compensation to reflect our
exposure to liabilities for p
ayment under the deferred plan.
The following table sets forth unrealized gains
(
losses
)
on
trading securities
held in the rabbi trust:
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|
|
|
|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Unrealized gains (losses) on trading securities held in rabbi trust
|
$
|
359
|
|
$
|
183
|
|
$
|
822
|
|
$
|
286
|
4
. Shareholders’ Equity
On May 23, 2017, we announced that our Board of Directors authorized the expenditure of up to an additional
$100,000
to repurchase shares of common stock, bringing the aggregate authorized expenditu
res for stock repurchases up to $2.3 billion.
Under the remaining repurchase authorizations, shares may be purchased from time to time in open market transactions, subject to market conditions.
During the
six
months ended
June 30,
201
7
,
we
repurchased
244
shares of common stock under authorized programs, for a total cost of $
104,
6
48
. The cumulative shares repurchased
under authorized programs as of June 30
, 201
7
,
were
7,107
for a total cost of $
2,102,457
. As of
June 30, 2017
, $
197,927
was available to rep
urchase shares under the announced
repurchase authorizations.
Shares repurchased
are being held in treasury stock until such time as they are reissued or retired at the discretion of the Board of Directors.
5. Stock-based Compensation
During the six months ended June 30, 2017, we granted stock only stock appreciation rights (“SOSARs”) on
298
shares of our common stock to eligible employees. The weighted average grant date fair value of the SOSARs was $
106.55
per share with a weighted average exercise price of $
429.02
per share based on the closing price of common stock on the date of grant. The SOSARs vest in two equal installments on the
second
and
third
anniversary of the grant date. During the six months ended June 30, 2017,
29
SOSARs were exercised and
72
SOSARs were forfeited.
During the six months ended June 30, 2017, we granted restricted stock units (“RSUs”) on
86
shares of our common stock to eligible employees. The weighted average grant
date fair value of the RSUs was
$430.21
per
share. The RSUs generally ve
st in two equal installments on the
second
and
third
anniversary of the grant date.
During the first quarter of 2017, we awarded
36
performance shares (“PSUs”) that are subject to service, market and performance vesting conditions.
Two-thirds
of the PSUs
had a grant date fair value of
$485.53
per
share and vest based on the price of our common stock reaching certain targets for a consecutive number of days during the
three
-year period
starting on the grant date and the quantity of
shares that will vest range from
0%
to
350%
of the targeted number of shares. The remaining one-third of PSUs had a grant date fair value of
$427.61
and vest based on reaching certain comparable restaurant sales increases during the
three
-year period starting on January
1, 2017, and the quantity of shares that will vest range from
0
% to
300
% of the targeted number of shares. If the defined minimum targets are not met, then no shares will vest.
During the six months ended June 30, 2017,
20
stock awards that were subject to service and performance or market conditions were forfeited.
The following table sets forth total stock based compensation expense:
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|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Stock based compensation expense
|
$
|
20,783
|
|
$
|
19,875
|
|
$
|
37,476
|
|
$
|
30,721
|
Stock based compensation expense, net of tax
|
$
|
12,713
|
|
$
|
11,945
|
|
$
|
22,924
|
|
$
|
18,463
|
Stock based compensation expense recognized as capitalized development
|
$
|
393
|
|
$
|
341
|
|
$
|
630
|
|
$
|
683
|
Excess tax benefit on stock based compensation recognized in provision for income taxes
|
$
|
422
|
|
$
|
-
|
|
$
|
664
|
|
$
|
-
|
6. Earnings (Loss) Per Share
Basic earnings (loss) per share is calculated by dividing income (loss) available to common shareholders by the weighted-average number of shares of common stock outstanding during each period. Diluted earnings (loss) per share (“diluted EPS”) is calculated using income (loss) available to common shareholders divided by diluted weighted-average shares of common stock outstanding during each period. Potentially dilutive securities include common shares related to SOSARs and non-vested stock awards (collectively “stock awards”). Diluted EPS considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an antidilutive effect. Stock awards are excluded from the calculation of diluted EPS in the event they are subject to performance conditions or are antidilutive.
The following stock awards were excluded from the calculation of diluted earnings (loss) per share:
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Three months ended June 30,
|
|
Six months ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Stock awards subject to performance conditions
|
|
247
|
|
|
290
|
|
|
244
|
|
|
301
|
Stock awards that were antidilutive
|
|
1,506
|
|
|
1,375
|
|
|
1,482
|
|
|
1,438
|
Total stock awards excluded from diluted earnings (loss) per share
|
|
1,753
|
|
|
1,665
|
|
|
1,726
|
|
|
1,739
|
The following table sets forth the computations of basic and diluted earnings (loss) per share:
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Three months ended June 30,
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|
Six months ended June 30,
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|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net income (loss)
|
$
|
66,730
|
|
$
|
25,596
|
|
$
|
112,850
|
|
$
|
(836)
|
Shares:
|
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|
Weighted average number of common shares outstanding
|
|
28,649
|
|
|
29,207
|
|
|
28,699
|
|
|
29,550
|
Dilutive stock awards
|
|
151
|
|
|
133
|
|
|
126
|
|
|
-
|
Diluted weighted average number of common shares outstanding
|
|
28,800
|
|
|
29,340
|
|
|
28,825
|
|
|
29,550
|
Basic earnings (loss) per share
|
$
|
2.33
|
|
$
|
0.88
|
|
$
|
3.93
|
|
$
|
(0.03)
|
Diluted earnings (loss) per share
|
$
|
2.32
|
|
$
|
0.87
|
|
$
|
3.92
|
|
$
|
(0.03)
|
7. Commitments and Contingencies
Data Security Incident
In April 2017, our information security team detected unauthorized activity on the network that supports payment processing for our restaurants, and immediately began an investigation with the help of leading computer security firms. We also self-reported the issue to payment card processors and law enforcement.
Our investigation
detected malware designed to access payment card data from cards used at point-of-sale devices at most Chipotle restaurants, primarily in the period from March 24, 2017 through April 18, 2017. The malware searched for track data, which may include cardholder name, card number, expiration date, and internal verification codes; however, no other customer information was affected. We have removed the malware from our systems and continue to evaluate ways to enhance our security measures.
We expect that substantially all of our investigation costs will be covered by insurance. It is not possible at this time to reasonably estimate the amount of any payment card network assessments or regulatory fines or penalties, for which our insurance coverage is limited, or other liabilities in connection with the incident.
Litigation Arising from Security Incident
On May 4, 2017, Bellwether Community Credit Union filed a purported class action complaint in the United States District Court for the District of Colorado alleging that we negligently failed to provide adequate security to protect the payment card information of customers of the plaintiffs and those of other similarly situated credit unions, banks and other financial institutions alleged to be part of the putative class, causing those institutions to suffer financial losses. The complaint also claims we were negligent per se based on alleged violations of Section 5 of the Federal Trade Commission Act and similar state laws. The plaintiff seeks monetary damages, injunctive relief and attorneys’ fees. On May 26, 2017, Alcoa Community Credit Union filed a purported class action complaint in the U. S. District Court for the District of Colorado making substantially the same allegations as the Bellwether complaint and seeking substantially the same relief. Bellwether and Alcoa have jointly moved to consolidate their cases, and a ruling on the consolidation motion remains pending.
On June 9, 2017, Todd Gordon filed a purported class action complaint in the U. S. District Court for the District of Colorado alleging that we negligently failed to provide adequate security to protect the payment card information of the plaintiff and other similarly situated customers alleged to be part of the putative class, causing such customers to suffer financial losses. The complaint also claims we were negligent per se based on alleged violations of Section 5 of the Federal Trade Commission Act and similar state laws, and also alleges breach of contract, unjust enrichment, and violations of the Arizona Consumer Fraud Act.
We intend to vigorously defend each of the aforementioned cases,
but it is not possible at this time to reasonably estimate the outcome of or any potential liability from these cases.
Although certain fees and costs associated with the data security incident and the aforementioned litigation to date have been paid or reimbursed by our cyber liability insurer, the ultimate amount of liabilities arising from the litigation may be in excess of the limits of our applicable insurance coverage.
Receipt of Grand Jury Subpoenas
On January 28, 2016
, we were served with a Federal Grand Jury Subpoena from the U.S. District Court for the Central District of California in connection with an official criminal investigation being conducted by the U.S. Attorney’s Office for the Central District of California, in conjunction with the U.S. Food and Drug Administration’s Office of Criminal Investigations. The subpoena requires the production of documents and information related to company-wide food safety matters dating back to January 1, 2013.
We received a follow-up subpoena on July 19, 2017 requesting information related to illness incidents associated with a single Chipotle restaurant in Sterling, Virginia.
We intend to continue to fully cooperate in the investigation. It is not possible at this time to determine whether we will incur, or to reasonably estimate the amount of, any fines or penalties in connection with the investigation pursuant to which the subpoena was issued.
Shareholder Derivative Actions
On April 6, 2016, Uri Skorski filed a shareholder derivative action in Colorado state court in Denver, Colorado, alleging that our Board of Directors and officers breached their fiduciary duties in connection with our alleged failure to disclose material information about our food safety policies and procedures, and also alleging that our Board of Directors and officers breached their fiduciary duties in connection with allegedly excessive compensation awarded from 2011 to 2015 under our stock incentive plan. On April 14, 2016, Mark Arnold and Zachary Arata filed a shareholder derivative action in Colorado state court in Denver, Colorado, making largely the same allegations as the Skorski complaint.
On May 26, 2016, the court issued an order consolidating the Skorski and Arnold/Arata actions into a single case. On August 8, 2016, Sean Gubricky filed a shareholder derivative action in the U.S. District Court for the District of Colorado, alleging that our Board of Directors and certain officers failed to institute proper food safety controls and policies, issued materially false and misleading statements in violation of federal securities laws, and otherwise breached their fiduciary duties to us. On September 1, 2016, Ross Weintraub filed a shareholder derivative action in Colorado state court in Denver, Colorado, making largely the same allegations as the Gubricky complaint.
On March 27, 2017, the Weintraub case was consolidated with the Skorski and Arnold/Arata action into a single case.
On December 27, 2016, Cyrus Lashkari filed a shareholder derivative action in the U.S. District Court for the District of Colorado, making largely the same allegations as the foregoing shareholder derivative complaints. Each of these actions purports to state a claim for damages on our behalf, and is based on statements in our SEC filings and related public disclosures, as well as media reports and company records. We intend to defend these cases vigorously, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from these cases.
Shareholder Class Action
s
On
January 8, 2016, Susie Ong filed a complaint in the U.S. District Court for the Southern District of New York on behalf of a purported class of purchasers of shares of our common stock between February 4, 2015 and January 5, 2016. The complaint purports to state claims against us, each of the co-Chief Executive Officers serving during the claimed class period and the Chief Financial Officer under Sections 10(b) and 20(a) of the Exchange Act and related rules, based on our alleged failure during the claimed class period to disclose material information about our quality controls and safeguards in relation to consumer and employee health. The complaint asserts that those failures and related public statements were false and misleading and that, as a result, the market price of our stock was artificially inflated during the claimed class period. The complaint seeks damages on behalf of the purported class in an unspecified amount, interest, and an award of reasonable attorneys’ fees, expert fees and other costs. On March 8, 2017, the court granted our motion to dismiss the complaint, with leave to amend. The plaintiff filed an amended complaint on April 7, 2017
.
Additionally, on
July 20, 2017, Elizabeth Kelly filed a complaint in the U.S. District Court for the District of Colorado on behalf of a purported class of purchasers of shares of our common stock between February 5, 2016 and July 19, 2017, with claims and factual allegations similar to the Ong complaint, based primarily on media reports regarding illnesses associated with a Chipotle restaurant in Sterling, Virginia. We intend to defend these cases vigorously, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from the cases.
Miscellaneous
We are 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 or more successful claims under which we incur greater liabilities than we currently anticipate, could materially and adversely affect our business, financial condition, results of operations and cash flows.