Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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You should read the following discussion together with Item 6. “Selected Financial Data” and our consolidated financial statements and related notes included in Item 8. “Financial Statements and Supplementary Data.” The discussion contains forward-looking statements involving risks, uncertainties and assumptions that could cause our results to differ materially from expectations. Factors that might cause such differences include those described in Item 1A. “Risk Factors” and elsewhere in this report.

Overview

Chipotle operates 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” experience. 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 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. Our approach is also guided by our belief in an idea we call “Food With Integrity.” Our objective is to find the highest quality ingredients we can—ingredients that are grown or raised with respect for the environment, animals, and people who grow or raise the food. A similarly focused people culture, with an emphasis on identifying and empowering top performing employees, enables us to develop future leaders from within.

2014 Highlights and Trends

Restaurant Development. As of December 31, 2014, we had 1,783 restaurants in operation, including 1,755 Chipotle restaurants throughout the United States, with an additional seven in Canada, six in England, three in France, and one in Germany. Our restaurants include nine ShopHouse Southeast Asian Kitchen restaurants, serving Asian-inspired cuisine, and we are an investor in a consolidated entity that owns and operates two Pizzeria Locale restaurants, a fast casual pizza concept. New restaurants have contributed substantially to our restaurant sales growth and we opened 192 restaurants in 2014, and expect to open between 190 and 205 restaurants in 2015, including a small number of ShopHouse and Pizzeria Locale restaurants.

Sales Growth. Average restaurant sales were $2.472 million as of December 31, 2014, increasing from $2.169 million as of December 31, 2013. We define average restaurant sales as the average trailing 12-month sales for restaurants in operation for at least 12 full calendar months. Our comparable restaurant sales increases were 16.8% in 2014. Comparable restaurant sales represent the change in period-over-period sales for restaurants beginning in their 13th full calendar month of operation. Comparable restaurant sales increases in 2014 were driven primarily by an increase in customer visits, and to a lesser extent from an increase in average check, including the impact of a menu price increase during the second quarter of 2014 at all U.S. Chipotle locations. Menu price increases accounted for 3.8% of our comparable restaurant sales increases for 2014. We expect 2015 comparable restaurant sales to be in the low to mid-single digits as comparisons become more difficult, particularly during the final three quarters of the year.

During 2013, we launched our catering service in Chipotle restaurants throughout the U.S, except New York City. Catering represented approximately 1.3% of revenue for the year ended 2014.

Food With Integrity. In all of our restaurants, we endeavor to serve only meats that were raised without the use of non-therapeutic antibiotics or added hormones, and in accordance with criteria we’ve established in an effort to improve sustainability and promote animal welfare. We brand these meats as “Responsibly Raised TM.” In addition, a portion of some of the produce items we serve is organically grown, and/or sourced locally when in season (by which we mean within 350 miles of the restaurant where it is served), and a portion of the beans we serve is organically grown and a portion is grown using conservation tillage methods that improve soil conditions, reduce erosion and help preserve the environment in which they are grown. The sour cream and cheese we buy is made with milk that comes from cows that are not given rBGH. Milk used to make much of our

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cheese and all of our sour cream is sourced from pasture-based dairies that provide an even higher standard of animal welfare by providing outdoor access for their cows. Further, we disclose on our website which ingredients contain genetically modified organisms, or GMOs, and we are working to replace ingredients containing GMOs in our food (not including beverages) with non-GMO ingredients. While the meat and poultry we serve is not genetically modified, the animals are likely fed a diet containing GMOs. We will continue to search for quality ingredients that not only taste delicious, but also benefit local farmers or the environment, or otherwise benefit or improve the sustainability of our supply chain.

One of our primary goals is for all of our restaurants to continue serving meats that are raised to meet our standards, but we have and will continue to face challenges in doing so. In January 2015, through an ongoing audit of our suppliers, we identified a pork supplier that was not meeting our standards related to the size and condition of the housing offered to some of the pigs, so we suspended our purchases from this supplier. Without this supply, we cannot get enough pork that meets our standards for all of our restaurants, and we will not be able to serve carnitas in about one-third of our U.S. restaurants until we can find additional sources which meet our standards to make up the shortfall. Because we have elected to remove all affected pork from our supply chain, including our distribution centers, and—because the meat is food safe but does not meet our rigorous standards—we disposed of it, primarily through donations to local food banks. Some of our restaurants served conventionally raised beef and chicken for periods during 2014 and we expect to serve conventionally raised beef in 2015, due to supply constraints for our Responsibly Raised meats. More of our restaurants may periodically serve conventionally raised meats in the future due to supply constraints. When we become aware that one or more of our restaurants will serve conventionally raised meat, we clearly and specifically disclose this temporary change on signage in each affected restaurant, so that customers can avoid those meats if they choose to do so.

Our food costs increased as a percentage of revenue in 2014 as a result of inflationary pressures on many of our ingredients, primarily beef, avocados, and dairy. The increase was partially offset by the impact of the menu price increase in the second quarter. We expect that food costs as a percentage of revenue in 2015 will remain consistent with the full year 2014 or will increase slightly.

Stock Repurchases. In accordance with stock repurchases authorized by our Board of Directors we purchased shares of our common stock with an aggregate total repurchase price of $88.0 million during 2014. As of December 31, 2014, $102.2 million was available to be repurchased under the current repurchase authorizations announced on February 5, 2013 and April 17, 2014. On February 3, 2015 we announced that our Board of Directors authorized the expenditure of up to an additional $100 million to repurchase shares of our common stock. We have entered into an agreement with a broker under SEC rule 10b5-1(c), authorizing the broker to make open market purchases of common stock from time to time, subject to market conditions. The existing repurchase agreement and the Board’s authorization of the repurchases may be modified, suspended, or discontinued at any time.

Restaurant Openings, Relocations and Closures

The following table details restaurant unit data for the years indicated.

		Years ended December 31
		2014				2013				2012
Beginning of period			1,595				1,410				1,230
Openings			192				185				183
Relocations			(4	)			—				(3	)
Total restaurants at end of period			1,783				1,595				1,410

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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 restaurants and hire more employees, our restaurant operating costs and depreciation and amortization increase.

Revenue

		Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Revenue		$	4,108.3			$	3,214.6			$	2,731.2				27.8	%			17.7	%
Average restaurant sales		$	2.472			$	2.169			$	2.113				14.0	%			2.7	%
Comparable restaurant sales increases			16.8	%			5.6	%			7.1	%
Number of restaurants as of the end of the period			1,783				1,595				1,410				11.8	%			13.1	%
Number of restaurants opened in the period, net of relocations			188				185				180

In 2014, the significant factors contributing to our increases in sales were comparable restaurant sales and new restaurant openings. Comparable restaurant sales increases contributed $530.0 million of the increase in restaurant sales, due primarily to increases in customer visits, and an increase in average check price, including the benefit from menu price increases. Restaurant sales from restaurants not yet in the comparable base contributed $364.7 million of the increase in sales in 2014, of which $173.9 million was attributable to restaurants opened during the year.

In 2013, the significant factors contributing to our increases in sales were new restaurant openings and comparable restaurant sales. Restaurant sales from restaurants not yet in the comparable restaurant base contributed $333.9 million of the increase in sales, of which $156.6 million was attributable to restaurants opened in 2013. Comparable restaurant sales increases contributed $150.3 million of the increase in restaurant sales, due primarily to increases in customer visits.

Food, Beverage and Packaging Costs

		Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Food, beverage and packaging		$	1,421.0			$	1,073.5			$	891.0				32.4	%			20.5	%
As a percentage of revenue			34.6	%			33.4	%			32.6	%

Food, beverage and packaging costs increased as a percentage of revenue in 2014 due to inflation on many food items, primarily beef, avocados, and dairy. The increase was partially offset by the impact of menu price increases. We expect that food costs as a percentage of revenue in 2015 will remain consistent with the full year 2014 or will increase slightly.

Food, beverage and packaging costs increased as a percentage of revenue in 2013 due to inflation on many food items, particularly salsa ingredients, as well as dairy, cooking oils, and chicken.

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Labor Costs

		For the Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Labor costs		$	904.4			$	739.8			$	641.8				22.3	%			15.3	%
As a percentage of revenue			22.0	%			23.0	%			23.5	%

Labor costs as a percentage of revenue decreased in 2014 due primarily to the benefit of higher average restaurant sales, including the impact of menu price increases, partially offset by an increased number of managers and crew in our restaurants and normal wage inflation. In 2015, we expect labor costs to increase slightly as a percentage of revenue due to the Affordable Care Act and minimum wage increases in a number of jurisdictions.

Labor costs as a percentage of revenue decreased in 2013 due primarily to the benefit of higher average restaurant sales.

Occupancy Costs

		For the Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Occupancy costs		$	230.9			$	199.1			$	171.4				16.0	%			16.1	%
As a percentage of revenue			5.6	%			6.2	%			6.3	%

Occupancy costs decreased as a percentage of revenue in 2014 and in 2013 primarily due to the benefit of higher average restaurant sales on a partially fixed-cost base.

Other Operating Costs

		For the Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Other operating costs		$	434.2			$	347.4			$	286.6				25.0	%			21.2	%
As a percentage of revenue			10.6	%			10.8	%			10.5	%

Other operating costs include, among other items, marketing and promotional costs, bank and credit card fees, and restaurant utilities and maintenance costs. Other operating costs decreased in 2014 due primarily to the benefit of higher average restaurant sales on a partially fixed-cost base. We expect marketing and promotional spend as a percentage of revenue for 2015 to remain consistent with the full year 2014 or increase slightly.

Other operating costs increased as a percentage of revenue in 2013 due primarily to higher spend on marketing and promotions.

General and Administrative Expenses

		For the Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
General and administrative expense		$	273.9			$	203.7			$	183.4				34.4	%			11.1	%
As a percentage of revenue			6.7	%			6.3	%			6.7	%

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The increase in general and administrative expenses in dollar terms in 2014 primarily resulted from increased non-cash stock-based compensation expense, higher payroll and bonus costs as we grew, as well costs from our biennial All Managers’ Conference, or AMC, held in the third quarter of 2014.

The increase in general and administrative expenses in dollar terms in 2013 primarily resulted from increased payroll and benefits costs as we grew and increased legal costs, partially offset by costs from our biennial AMC held during 2012, as well as a decrease in 2013 in non-cash stock based compensation expense due to expenses in 2012 related to non-vested stock awards subject to performance conditions.

Depreciation and Amortization

		For the Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Depreciation and amortization		$	110.5			$	96.1			$	84.1				15.0	%			14.2	%
As a percentage of revenue			2.7	%			3.0	%			3.1	%

As a percentage of revenue, depreciation and amortization decreased in 2014 and 2013 as a result of the benefit of higher average restaurant sales on a partially fixed-cost base.

Income Tax Provision

		For the Years ended December 31												% increase 2014 over 2013				% increase 2013 over 2012
	2014				2013				2012
		(dollars in millions)
Provision for income taxes		$	268.9			$	207.0			$	179.7				29.9	%			15.2	%
Effective tax rate			37.6	%			38.7	%			39.3	%

The 2014 effective tax rate decreased by 1.1% from 2013 due to a decrease in the state tax rate and filing the 2013 tax returns, which included a change in the estimate of usable employer credits.

The 2013 effective tax rate decreased by 0.6% from 2012 due primarily to certain federal tax credits that were extended in 2013, for both 2013 and 2012, which benefited the rate by 1.1%. This decrease was partially offset by non-recurring adjustments related to state income taxes.

We estimate our 2015 annual effective tax rate will be 39.0%, increasing from 2014 due to the expiration of certain federal tax credits.

Quarterly Financial Data/Seasonality

The following table presents data from the consolidated statement of income and comprehensive income for each of the eight quarters in the period ended December 31, 2014. The operating results for any quarter are not necessarily indicative of the results for any subsequent quarter.

		2014 Quarters Ended
		March 31				June 30				September 30				December 31
Revenue		$	904.2			$	1,050.1			$	1,084.2			$	1,069.8
Operating income		$	135.7			$	179.8			$	207.4			$	187.9
Net income		$	83.1			$	110.3			$	130.8			$	121.2
Number of restaurants opened in quarter			44				45				43				60
Comparable restaurant sales increase			13.4	%			17.3	%			19.8	%			16.1	%

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		2013 Quarters Ended
		March 31				June 30				September 30				December 31
Revenue		$	726.8			$	816.8			$	826.9			$	844.1
Operating income		$	120.0			$	146.4			$	137.2			$	129.1
Net income		$	76.6			$	87.9			$	83.4			$	79.6
Number of restaurants opened in quarter			48				44				37				56
Comparable restaurant sales increase			1.0	%			5.5	%			6.2	%			9.3	%

Seasonal factors cause our profitability to fluctuate from quarter to quarter. Historically, our average daily restaurant sales and net income 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. Seasonal factors, however, might be moderated or outweighed by other factors that may influence our quarterly results, such as fluctuations in food or packaging costs or the timing of menu price increases. The number of trading days in a quarter can also affect our results. Overall, on an annual basis, changes in trading dates do not have a significant impact on our results.

Our quarterly results are also affected by other factors such as the amount and timing of non-cash stock-based compensation expense, the number of new restaurants opened in a quarter and unanticipated events. New restaurants typically 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. In addition, unanticipated events also impact our results. 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 have a cash and short-term investment balance of $758.1 million that we expect to utilize, along with cash flow from operations, to provide capital to support the growth of our business (primarily through opening restaurants), to repurchase additional shares of our common stock subject to market conditions (including up to $102.2 million in repurchases under programs authorized as of December 31, 2014 and an additional $100 million program announced on February 3, 2015), to maintain our existing restaurants and for general corporate purposes. We also have a long term investments balance of $496.1 million, which consists of U.S. treasury notes and certificate of deposit products with maturities of 13 months to approximately 2 years. We believe that cash from operations, together with our cash and investment balances, will be enough to meet ongoing capital expenditures, working capital requirements and other cash needs for the foreseeable future.

We haven’t required significant working capital because customers generally pay using cash or credit and debit 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 our growth.

While operations continue to provide cash, our primary use of cash is in new restaurant development. Our total capital expenditures for 2014 were $252.6 million, which included the purchase of a corporate aircraft for a total cost of approximately $24 million; the majority of that amount was paid during 2014. We expect to incur capital expenditures of about $235 million in 2015, of which about $180 million relates to our construction of new restaurants before any reductions for landlord reimbursements, and the remainder primarily relates to restaurant reinvestments. In 2014, for Chipotle restaurants in the U.S., we spent on average about $843,000 in development and construction costs per restaurant, net of landlord reimbursements of approximately $60,000, and for all restaurants including international locations we spent on average about $849,000, net of landlord reimbursements of approximately $66,000. For new restaurants to be opened in 2015, we anticipate average development costs will slightly decrease due primarily to the mix of locations and categories.

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Contractual Obligations

Our contractual obligations as of December 31, 2014 were as follows:

		2014
		Total				1 year				2-3 years				4-5 years				After 5 years
		(in thousands)
Operating leases		$	3,044,197			$	206,413			$	417,338			$	423,587			$	1,996,859
Deemed landlord financing		$	4,717			$	401			$	844			$	846			$	2,626
Other contractual obligations(1)		$	221,584			$	218,191			$	3,393			$	—			$	—
Total contractual cash obligations		$	3,270,498			$	425,005			$	421,575			$	424,433			$	1,999,485

(1)	We enter into various purchase obligations in the ordinary course of business. Those that are binding primarily relate to amounts owed for orders related to produce and other ingredients and supplies, construction contractor and subcontractor agreements, orders submitted for equipment for restaurants under construction, and marketing initiatives and corporate sponsorships.

We’re obligated under non-cancelable leases for our restaurants and administrative offices. Our leases generally have initial terms of either five to ten years with two or more five-year extensions, for end-cap and in-line restaurants, or 15 to 20 years with several five-year extensions, for free-standing restaurants. Our leases generally require us to pay a proportionate share of real estate taxes, insurance, common charges and other operating costs. Some restaurant leases provide for contingent rental payments based on sales thresholds, although we generally do not expect to pay significant contingent rent on these properties based on the thresholds in those leases.

Off-Balance Sheet Arrangements

As of December 31, 2014 and 2013, we had no off-balance sheet arrangements or obligations.

Inflation

The primary areas of our operations affected by inflation are food, healthcare costs, labor, fuel, utility costs, materials used in the construction of our restaurants, and insurance. Although almost all of our crew members make more than the federal and applicable state and local minimum wage, increases in the applicable federal or state minimum wage may have an impact on our labor costs. Additionally, many of our leases require us to pay taxes, maintenance, utilities and insurance, all of which are generally subject to inflationary increases. Inflationary increases have increased our food, beverage, and packaging costs as a percentage of revenue for the past three years. These increases have been partially offset with menu price increases.

Critical Accounting Estimates

We describe our significant accounting policies in Note 1 of our consolidated financial statements included in Item 8. “Financial Statements and Supplementary Data.” 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 factors. We believe the following critical accounting estimates affect our more significant judgments and estimates used in the preparation of our financial statements:

Leases

We lease nearly all of our restaurant locations. Our leases typically contain escalating rentals over the lease term as well as optional renewal periods. We have estimated that our lease term, including reasonably assured renewal periods, is the lesser of the lease term or 20 years. We account for our leases by recognizing rent expense

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on a straight-line basis over the reasonably assured lease term. The majority of our leasehold improvements are also depreciated over the reasonably assured lease term. If the estimate of our reasonably assured lease term was changed, our depreciation and rent expense could differ materially.

Stock-based Compensation

We recognize compensation expense for equity awards over the vesting period based on the award’s fair value. We use the Black-Scholes valuation model to determine the fair value of our stock-only stock appreciation rights, or SOSARs, which requires assumptions to be made regarding our stock price volatility, the expected life of the award and expected dividend rates. The volatility assumption was based on our historical data and implied volatility, and the expected life assumptions were based on our historical data. Similarly, the compensation expense of performance share awards and SOSARs with performance-based vesting conditions is based in part on the estimated probability of our achieving levels of performance associated with particular levels of payout for performance shares and with vesting for performance SOSARs. We determine the probability of achievement of future levels of performance by comparing the relevant performance level with our internal estimates of future performance. Those estimates are based on a number of assumptions, and different assumptions may have resulted in different conclusions regarding the probability of our achieving future levels of performance relevant to the payout levels for the awards. Had we arrived at different assumptions of stock price volatility or expected lives of our SOSARs, or different assumptions regarding the probability of our achieving future levels of performance with respect to performance share awards and performance SOSARs, our stock-based compensation expense and results of operations could have been different.

Insurance Liability

We maintain various insurance policies for workers’ compensation, general liability and auto damage with varying deductibles as high as $1 million, and for property which generally has a $1.5 million deductible. We are self insured for employee health but have third party insurance coverage to limit exposure to these claims. We record a liability that represents our estimated cost of claims incurred and unpaid as of the balance sheet date. Our estimated liability is not discounted and is based on a number of assumptions and factors, including historical trends, actuarial assumptions and economic conditions, and is closely monitored and adjusted when warranted by changing circumstances. In addition, our history of claims experience is short and our significant growth rate could affect the accuracy of estimates based on historical experience. Should a greater amount of claims occur compared to what was estimated or medical costs increase beyond what was expected, our accrued liabilities might not be sufficient and additional expenses may be recorded. Actual claims experience could also be more favorable than estimated, which would result in expense reductions. Unanticipated changes may produce materially different amounts of expense than that reported under these programs. The total estimated insurance liabilities as of December 31, 2014 were $34.0 million.

Reserves/Contingencies for Litigation and Other Matters

We are involved in various claims and legal actions that arise in the ordinary course of business. These actions are subject to many uncertainties, and we cannot predict the outcomes with any degree of certainty. Consequently, we were unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters as of December 31, 2014 and 2013. Although we have recorded liabilities related to a number of legal actions, our estimates used to determine the amount of these liabilities may not be accurate, and there are other legal actions for which we have not recorded a liability. As a result, in the event legal actions for which we have not accrued a liability or for which our accrued liabilities are not accurate are resolved, such resolution may affect our operating results and cash flows.

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