Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm42
Consolidated Balance Sheet as of December 31, 2018 and 201743
Consolidated Statement of Income and Consolidated Statement of Comprehensive Income for the years ended December 31, 2018, 2017 and 201644
Consolidated Statement of Shareholders’ Equity for the years ended December 31, 2018, 2017 and 201645
Consolidated Statement of Cash Flows for the years ended December 31, 2018, 2017 and 201646
Notes to Consolidated Financial Statements47

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors of Chipotle Mexican Grill, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Chipotle Mexican Grill, Inc. (the Company) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 7, 2019 expressed an unqualified opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Ernst & Young LLP

We have served as the Company’s auditor since 1997.

Irvine, California

February 7, 2019

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED BALANCE SHEET

(in thousands, except per share data)

December 31,
20182017
Assets
Current assets:
Cash and cash equivalents$249,953$184,569
Accounts receivable62,31240,453
Inventory21,55519,860
Prepaid expenses and other current assets54,12950,918
Income tax receivable-9,353
Investments426,845324,382
Total current assets814,794629,535
Leasehold improvements, property and equipment, net1,379,2541,338,366
Restricted cash30,19929,601
Other assets19,33226,251
Goodwill21,93921,939
Total assets$2,265,518$2,045,692
Liabilities and shareholders' equity
Current liabilities:
Accounts payable$113,071$82,028
Accrued payroll and benefits113,46782,541
Accrued liabilities147,84995,679
Unearned revenue70,47463,645
Income tax payable5,129-
Total current liabilities449,990323,893
Commitments and contingencies (Note 13)
Deferred rent330,985316,498
Deferred income tax liability11,566814
Other liabilities31,63840,042
Total liabilities824,179681,247
Shareholders' equity:
Preferred stock, $0.01 par value, 600,000 shares authorized, no shares issued as of December 31, 2018 and 2017, respectively--
Common stock, $0.01 par value, 230,000 shares authorized, 35,973 and 35,852 shares issued as of December 31, 2018 and 2017, respectively360359
Additional paid-in capital1,374,1541,305,090
Treasury stock, at cost, 8,276 and 7,826 common shares at December 31, 2018 and 2017, respectively(2,500,556)(2,334,409)
Accumulated other comprehensive income (loss)(6,236)(3,659)
Retained earnings2,573,6172,397,064
Total shareholders' equity1,441,3391,364,445
Total liabilities and shareholders' equity$2,265,518$2,045,692

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED STATEMENT OF INCOME

(in thousands, except per share data)

Year ended December 31,
201820172016
Revenue$4,864,985$4,476,412$3,904,384
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
Food, beverage and packaging1,600,7601,535,4281,365,580
Labor1,326,0791,205,9921,105,001
Occupancy347,123327,132293,636
Other operating costs680,031651,644641,953
General and administrative expenses375,460296,388276,240
Depreciation and amortization201,979163,348146,368
Pre-opening costs8,54612,34117,162
Impairment, closure costs, and asset disposals66,63913,34523,877
Total operating expenses4,606,6174,205,6183,869,817
Income from operations258,368270,79434,567
Interest and other income, net10,0684,9494,172
Income before income taxes268,436275,74338,739
Provision for income taxes(91,883)(99,490)(15,801)
Net income$176,553$176,253$22,938
Earnings per share:
Basic$6.35$6.19$0.78
Diluted$6.31$6.17$0.77
Weighted-average common shares outstanding:
Basic27,82328,49129,265
Diluted27,96228,56129,770

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(in thousands)

Year ended December 31,
201820172016
Net income$176,553$176,253$22,938
Other comprehensive income (loss), net of income taxes:
Foreign currency translation adjustments(2,736)4,689(1,291)
Unrealized gain (loss) on available-for-sale securities291(274)2,251
Tax benefit (expense)(132)88(849)
Other comprehensive income (loss), net of income taxes(2,577)4,503111
Comprehensive income$173,976$180,756$23,049

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(in thousands)

Common StockTreasury StockAccumulated Other Comprehensive Income (Loss)
SharesAmountAdditional Paid-In CapitalSharesAmountRetained EarningsAvailable-for-Sale SecuritiesForeign Currency TranslationTotal
Balance, December 31, 201535,790$358$1,172,6285,206$(1,234,612)$2,197,873$(1,522)$(6,751)$2,127,974
Stock-based compensation65,11265,112
Stock plan transactions and other43-(185)(185)
Excess tax benefit on stock-based compensation1,3201,320
Acquisition of treasury stock1,813(814,777)(814,777)
Net income22,93822,938
Other comprehensive income (loss), net of income tax1,402(1,291)111
Balance, December 31, 201635,833$358$1,238,8757,019$(2,049,389)$2,220,811$(120)$(8,042)$1,402,493
Stock-based compensation66,39666,396
Stock plan transactions and other191(181)(180)
Acquisition of treasury stock807(285,020)(285,020)
Net income176,253176,253
Other comprehensive income (loss), net of income tax(186)4,6894,503
Balance, December 31, 201735,852$359$1,305,0907,826$(2,334,409)$2,397,064$(306)$(3,353)$1,364,445
Stock-based compensation69,94769,947
Stock plan transactions and other1211(883)(882)
Acquisition of treasury stock450(166,147)(166,147)
Net income176,553176,553
Other comprehensive income (loss), net of income tax159(2,736)(2,577)
Balance, December 31, 201835,973$360$1,374,1548,276$(2,500,556)$2,573,617$(147)$(6,089)$1,441,339

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands)

Year ended December 31,
201820172016
(as adjusted)(1)(as adjusted)(1)
Operating activities
Net income$176,553$176,253$22,938
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization201,979163,348146,368
Deferred income tax (benefit) provision10,585(18,026)(14,207)
Impairment, closure costs, and asset disposals61,98713,34523,877
Bad debt allowance125214(262)
Stock-based compensation expense69,16465,25564,166
Other(2,918)(218)(1,924)
Changes in operating assets and liabilities:
Accounts receivable(8,298)(140)(1,923)
Inventory(1,722)(5,250)(91)
Prepaid expenses and other current assets(3,811)(6,710)(4,259)
Other assets(2,005)(1,476)1,063
Accounts payable32,08010,908(6,734)
Accrued payroll and benefits29,5686,18811,416
Accrued liabilities14,83128,17913,692
Unearned revenue6,8294,2078,383
Income tax payable/receivable14,439(4,173)54,340
Deferred rent21,29729,99637,030
Other long-term liabilities8696,3161,287
Net cash provided by operating activities621,552468,216355,160
Investing activities
Purchases of leasehold improvements, property and equipment(287,390)(216,777)(258,842)
Purchases of investments(485,188)(199,801)-
Maturities of investments385,000330,00045,000
Proceeds from sale of investments--540,648
Net cash provided by (used in) investing activities(387,578)(86,578)326,806
Financing activities
Acquisition of treasury stock(160,937)(285,218)(836,760)
Tax withholding on share-based compensation awards(5,411)(702)(895)
Stock plan transactions and other financing activities(187)261,372
Net cash used in financing activities(166,535)(285,894)(836,283)
Effect of exchange rate changes on cash and cash equivalents and restricted cash(1,457)2,056110
Net change in cash, cash equivalents, and restricted cash65,98297,800(154,207)
Cash, cash equivalents, and restricted cash at beginning of period214,170116,370270,577
Cash, cash equivalents, and restricted cash at end of period$280,152$214,170$116,370
Supplemental disclosures of cash flow information
Income taxes paid$67,053$119,787$23,862
Increase (decrease) in purchases of leasehold improvements, property, and equipment accrued in accounts payable and accrued liabilities$(936)$(7,690)$(1,781)
Increase (decrease) in acquisition of treasury stock accrued in accrued liabilities$200$(900)$(22,778)
(1)Balances were adjusted due to the adoption of Financial Accounting Standards Board Accounting Standards Update No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash” as discussed in further detail in Note 1. “Description of Business and Summary of Significant Accounting Policies Recent Accounting Standards”

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

  1. Description of Business and Summary of Significant Accounting Policies

In this annual report on Form 10-K, 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 relevant menu of burritos, burrito bowls, tacos, and salads, made using fresh, high-quality ingredients. As of December 31, 2018, we operated 2,452 Chipotle restaurants throughout the United States as well as 37 international Chipotle restaurants and two non-Chipotle restaurants. We manage our operations and restaurants based on eight regions that aggregate into one reportable segment.

Principles of Consolidation and Basis of Presentation

Our consolidated financial statements include our accounts and our wholly and majority owned subsidiaries after elimination of all intercompany accounts and transactions.

Management Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates under different assumptions or conditions.

Revenue Recognition

We generally recognize revenue, net of discounts and incentives, when payment is tendered at the point of sale. We report revenue net of sales-related taxes collected from customers and remitted to governmental taxing authorities. We recognize a liability for offers of free food by estimating the cost to satisfy the offer based on company-specific historical redemption patterns for similar promotions. These costs are recognized in other operating costs on the consolidated statements of income and in accrued liabilities on the consolidated balance sheets.

Delivery

We offer our customers delivery in certain geographic regions. Delivery services are fulfilled by third-party service providers. In some cases, we make delivery sales through Chipotle.com or the Chipotle App (“White Label Sales”). In other cases, we make delivery sales through a non-Chipotle owned channel, such as the delivery partner’s website or app (“Marketplace Sales”). With respect to White Label Sales, we control the delivery services and generally recognize revenue, including delivery fees, when the delivery partner transfers food to the customer. For these sales, we receive payment directly from the customer at the time of sale. With respect to Marketplace Sales, we generally recognize revenue, excluding delivery fees, when control of the food is transferred to the delivery partner and we receive payment subsequent to the transfer of food. The payment terms with respect to Marketplace Sales are short-term in nature.

Gift Cards

We sell gift cards, which do not have expiration dates and we do not deduct non-usage fees from outstanding gift card balances. We recognize revenue from gift cards when the gift card is redeemed by the customer. In addition, we also recognize revenue when we determine the likelihood of the gift card being redeemed by the customer is remote (gift card breakage) and there is not a legal obligation to remit the unredeemed gift cards to the relevant jurisdiction. Gift card breakage is recognized in revenue as the gift cards are used on a pro rata basis over an eight-month period beginning at the date of the gift card sale and is included in revenue on the consolidated statement of income. We have determined that 4% of gift card sales will not be redeemed and will be retained by us. Gift card liability balances are typically highest at the end of each calendar year following increased gift card sales during the holiday season; accordingly, revenue recognized from gift card liability balances is highest in the first quarter of each calendar year.

Chipotle Rewards

Effective October 2018, we launched a loyalty program, Chipotle Rewards, in three test markets. Eligible customers who enroll in the program generally earn points for every dollar spent. After accumulating a certain number of points, the customer earns a reward that can be redeemed for a free entrée. We may also periodically offer promotions, which provide the customer with the

opportunity to earn bonus points or free food. Earned rewards generally expire one to six months after they are issued, and points generally expire if an account is inactive for a period of six months.

We defer revenue associated with the estimated selling price of points earned by program members as each point is earned. The estimated selling price of each point earned is based on the estimated value of product for which the reward is expected to be redeemed, net of points we do not expect to be redeemed. Our estimate of points we expect to be redeemed is based on historical company specific data. We recognize loyalty revenue when a customer redeems an earned reward. Deferred revenue associated with Chipotle Rewards is included in unearned revenue in our consolidated balance sheet.

Cash and Cash Equivalents

We consider highly liquid investment instruments purchased with an initial maturity of three months or less to be cash equivalents. We maintain cash and cash equivalent balances that exceed federally-insured limits with a number of financial institutions.

Restricted Cash

We maintain certain cash balances restricted as to withdrawal or use. Restricted cash assets are primarily insurance-related restricted trust assets.

Accounts Receivable

Accounts receivable primarily consists of receivables from third party gift card distributors, tenant improvement receivables from landlords, vendor rebates, delivery receivables and interest receivable. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable based on a specific review of account balances. Account balances are charged against the allowance after all means of collection have been exhausted and the potential for recoverability is considered remote. The allowance for doubtful accounts is zero for December 31, 2018 and 2017, respectively.

Inventory

Inventory, consisting principally of food, beverages, and supplies, is valued at the lower of first-in, first-out cost or net realizable value. Certain key ingredients (beef, pork, chicken, beans, rice, sour cream, cheese, and tortillas) are purchased from a small number of suppliers.

Investments

Investments classified as trading securities are carried at fair value with any unrealized gain or loss being recorded in the consolidated statement of income. Investments classified as available-for-sale are carried at fair value with unrealized gains and losses, net of tax, included as a component of other comprehensive income (loss) on the statement of comprehensive income. Held-to-maturity securities are carried at amortized cost. Impairment charges on investments are recognized in interest and other income, net on the consolidated statement of income when management believes the decline in the fair value of the investment is other-than-temporary.

Leasehold Improvements, Property and Equipment

Leasehold improvements, property and equipment are recorded at cost. Internal costs directly associated with the acquisition, development and construction of a restaurant are capitalized and were $6,285 and $7,507 as of December 31, 2018 and 2017, respectively. Expenditures for major renewals and improvements are capitalized while expenditures for minor replacements, maintenance and repairs are expensed as incurred. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term, which generally include option periods that are reasonably assured, or the estimated useful lives of the assets. Upon retirement or disposal of assets, the accounts are relieved of cost and accumulated depreciation and any related gain or loss is reflected in loss on disposal and impairment of assets in the consolidated statement of income.

At least annually, we evaluate, and adjust when necessary, the estimated useful lives of leasehold improvements, property and equipment. The changes in estimated useful lives did not have a material impact on depreciation in any period. The estimated useful lives are:

Leasehold improvements and buildings3-20 years
Furniture and fixtures4-7 years
Equipment3-10 years

Goodwill

Goodwill is not subject to amortization, but instead is tested for impairment at least annually, and we are required to record any necessary impairment adjustments. Impairment is measured as the excess of the carrying value over the fair value of the goodwill. No impairment charges were recognized on goodwill for the years ended December 31, 2018, 2017 and 2016.

Other Assets

Other assets consist primarily of a rabbi trust as described further in Note 10. “Employee Benefit Plans,” transferable liquor licenses which are carried at the lower of fair value or cost, fixed asset deposits, and rental deposits related to leased properties.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For the purpose of reviewing restaurant assets to be held and used for potential impairment, assets are grouped together at the market level, or in the case of a potential relocation or closure, at the restaurant level. We manage our restaurants as a group with significant common costs and promotional activities; as such, an individual restaurant’s cash flows are not generally independent of the cash flows of others in a market.

The fair value measurement for asset impairment is based on Level 3 inputs. See “Fair Value Measurements” below for a description of level inputs. We first compare the carrying value of the asset to the asset’s estimated future undiscounted cash flows. If the estimated undiscounted future cash flows are less than the carrying value of the asset, we determine if we have an impairment loss by comparing the carrying value of the asset to the asset's estimated fair value. The estimated fair value of the asset is generally determined using a discounted cash flow projection model. In certain cases, management uses other market information, when available, to estimate the fair value of an asset. The impairment charges represent the excess of each asset’s carrying amount over its estimated fair value.

Income Taxes

We compute income taxes using the asset and liability method, under which deferred income tax assets and liabilities are recognized based on the differences between the financial reporting bases and the respective tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using current enacted tax rates expected to apply to taxable income in the years in which we expect the temporary differences to reverse. Any effects of changes in income tax rates or tax laws are included in the provision for income taxes in the period that includes the enactment date.

We routinely assess the realizability of our deferred tax assets by jurisdiction and may record a valuation allowance if, based on all available positive and negative evidence, we determine that some portion of the deferred tax assets may not be realized prior to expiration. If we determine that we may be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes during the period in which the determination was made that the deferred tax asset can be realized.

We evaluate our tax exposures associated with our various tax filing positions and recognize a tax benefit from an uncertain tax position only if it is more likely than not that based on its technical merits the tax position will be sustained upon examination by the relevant taxing authorities, including resolutions of any related appeals or litigation processes. The tax benefits recognized in the financial statements from such a position are measured based on the largest tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority. For uncertain tax positions that do not meet this threshold, we record a related tax liability in the period in which it arises. We adjust our unrecognized tax benefit liability and income tax expense in the period in which the uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position or when new information becomes available that requires a change in recognition and/or measurement of the liability.

We recognize interest to be paid on an underpayment of income taxes in interest expense and any related statutory penalties in the provision for income taxes in our consolidated statement of income. Accrued interest and penalties are included within the related tax liability on our consolidated balance sheet.

Restaurant Pre-Opening Costs

Pre-opening costs, including rent, wages, benefits and travel for training and opening teams, food and other restaurant operating costs, are expensed as incurred prior to a restaurant opening for business, and are included in operating expenses on the consolidated statement of income.

Insurance Liability

We are self-insured for a significant portion of our risks and associated liabilities with respect to workers’ compensation, general liability, employee health, property and auto damage. Predetermined loss limits have been arranged with third party insurance companies 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.

Reserves/Contingencies for Litigation and Other Matters

We are involved in various claims and legal actions that arise in the ordinary course of business. We record an accrual for legal contingencies when we determine that it is probable that we have incurred a liability and we can reasonably estimate the amount of the loss.

Advertising and Marketing Costs

Advertising and marketing costs are expensed as incurred and totaled $111,695, $106,345 and $102,969 for the years ended December 31, 2018, 2017 and 2016, respectively. Advertising and marketing costs are included in other operating costs on the consolidated statement of income.

Rent

Rent expense for our leases, which generally have escalating rentals over the term of the lease, is recorded on a straight-line basis over the lease term. The lease term is the lesser of 20 years inclusive of reasonably assured renewal periods, or the lease term. The lease term begins when we have the right to control the use of the property, which is typically before rent payments are due under the lease. The difference between the rent expense and rent paid is recorded as deferred rent on the consolidated balance sheet. Pre-opening rent is included in pre-opening costs on the consolidated statement of income. Tenant incentives used to fund leasehold improvements are recorded in deferred rent and amortized as reductions of rent expense over the term of the lease.

Additionally, certain operating leases contain clauses that provide additional contingent rent based on a percentage of sales greater than certain specified target amounts. Contingent rent expense is recognized provided the achievement of that target is considered probable.

We record a liability for lease termination costs at the date we cease using a property, consisting of the net present value of remaining lease obligations, net of estimated sublease rentals that could be reasonably obtained, and measure fair value using Level 3 inputs (unobservable inputs) based on a discounted cash flow method. Any subsequent adjustments to that liability as a result of lease termination or changes in estimates of sublease income are recorded in the period incurred.

Stock-Based Compensation

We issue shares as part of employee compensation pursuant to the Amended and Restated Chipotle Mexican Grill, Inc. 2011 Stock Incentive Plan (the “2011 Incentive Plan”). Stock-only stock appreciation rights, or SOSARs, and stock awards generally vest equally over two and three years and expire after seven years. Stock-based compensation expense is generally recognized on a straight-line basis for each separate vesting portion. Compensation expense related to employees eligible to retire and retain full rights to the awards is recognized over six months which coincides with the notice period. We estimate forfeitures based on historical data when determining the amount of stock-based compensation costs to be recognized in each period. We have also granted SOSARs and stock awards with performance vesting conditions and/or market vesting conditions. Stock awards with performance or market vesting conditions generally vest based on our achievement versus stated targets or criteria over a three-year performance and service period. Compensation expense on SOSARs subject to performance conditions is recognized over the longer of the estimated performance goal attainment period or time vesting period. Compensation expense on stock awards subject to performance conditions, which is based on the quantity of awards we have determined are probable of vesting, is recognized over the longer of the estimated performance goal attainment period or time vesting period. Compensation expense is recognized ratably for awards subject to market conditions regardless of whether the market condition is satisfied, provided that the requisite service has been provided. Some stock-based compensation awards are made to employees involved in our new restaurant development activities, and expense for these awards is recognized as capitalized development and included in leasehold improvements, property and equipment on the consolidated balance sheet.

Fair Value Measurements

Fair value is the price we would receive to sell an asset or pay to transfer a liability (exit price) in an orderly transaction between market participants. For assets and liabilities recorded or disclosed at fair value on a recurring basis, we determine fair value based on the following:

Level 1: Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.

Level 2: Observable inputs other than prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated with observable market data.

Level 3: Unobservable inputs for the asset or liability. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

Foreign Currency Translation

Our international operations use the local currency as the functional currency. Assets and liabilities are translated at exchange rates in effect as of the balance sheet date. Income and expense accounts are translated at the average monthly exchange rates during the year. Resulting translation adjustments are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income.

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 (“diluted EPS”) 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 shares of common stock underlying 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 anti-dilutive effect. Stock awards are excluded from the calculation of diluted EPS in the event they are subject to performance conditions or are antidilutive.

Recently Issued Accounting Standards

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40)”: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which clarifies the accounting for implementation costs in cloud computing arrangements. ASU 2018-15 is effective for us in the first quarter of fiscal 2020, and early adoption is permitted. The adoption of ASU 2018-15 is still being evaluated on our consolidated financial statements.

In February 2016, FASB issued ASU 2016-02, “Leases (Topic 842),” and issued additional clarifications and improvements throughout 2018. The pronouncement requires lessees to recognize a liability for lease obligations, which represents 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 that is intended to give financial statement users the ability to assess the amount, timing, and potential uncertainty of cash flows related to leases. We have adopted the requirements of the new lease standard effective January 1, 2019. We have elected the optional transition method to apply the standard as of the effective date and therefore, we will not apply the standard to the comparative periods presented in our financial statements. At the beginning of the period of adoption, we will recognize a cumulative-effect adjustment in retained earnings due to impairment of certain right-of-use assets at the effective date. We will elect the transition package of three practical expedients permitted within the standard, which eliminates the requirements to reassess prior conclusions about lease identification, lease classification, and initial direct costs. We will not elect the hindsight practical expedient, which permits the use of hindsight when determining lease term and impairment of right-of-use assets. Further, we will elect a short-term lease exception policy, permitting us to not apply the recognition requirements of this standard to short-term leases (i.e. leases with terms of 12 months or less) and an accounting policy to account for lease and non-lease components as a single component for certain classes of assets. We are finalizing the impact of the standard to our accounting policies, processes, disclosures, and internal control over financial reporting and have implemented necessary upgrades to our existing lease system.

The adoption of ASU 2016-02 will have a significant impact on our consolidated balance sheet as we will record material assets and obligations primarily related to approximately 2,500 restaurant operating leases and corporate office leases. We expect to record operating lease liabilities of approximately $2.7 billion based on the present value of the remaining minimum rental payments using discount rates as of the effective date. We expect to record corresponding right-of-use assets of approximately $2.4 billion, based upon the operating lease liabilities adjusted for prepaid and deferred rent, unamortized initial direct costs, liabilities associated with lease

termination costs and impairment of right-of-use assets recognized in retained earnings as of January 1, 2019. We do not expect a material impact on our consolidated statement of income or our consolidated statement of cash flows.

Furthermore, we have evaluated our existing sales and leaseback transactions, which do not qualify for sale leaseback accounting under ASC 840, and determined that these transactions do not qualify for sale leaseback accounting under ASC 842 due to fixed price renewal options prohibiting sale accounting. These transactions will continue to be accounted for under the financing method upon transition to ASC 842.

We reviewed all other recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact to the consolidated financial statements.

Recently Adopted Accounting Standard

During the first quarter of 2018, we adopted ASU 2014-09 “Revenue from Contracts with Customers (Topic 606),” which 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. The adoption did not have an impact on the consolidated balance sheet, statements of income, or cash flows. The primary impact of adoption was the enhancement of our disclosures related to gift cards and certain promotional activity included in Note 1. “Description of Business and Summary of Significant Accounting Policies” and Note 3. “Revenue Recognition.”

During the first quarter of 2018, we retrospectively adopted ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash,” which requires restricted cash to be classified with cash and cash equivalents when reconciling the beginning of period and end of period total amounts on the statement of cash flows. Accordingly, we reclassified $29,601 and $28,490 of restricted cash into cash, cash equivalents, and restricted cash as of December 31, 2017 and December 31, 2016, for a total balance of $214,170 and $116,370, which resulted in a $1,111 and $5,918 increase in net cash provided by operating activities in the consolidated statement of cash flows for the twelve months ended December 31, 2017 and December 31, 2016, respectively. Restricted cash assets are primarily insurance related restricted trust assets.

  1. Supplemental Financial Information

Leasehold improvements, property and equipment were as follows:

December 31,
20182017
Land$12,943$12,943
Leasehold improvements and buildings1,689,8731,635,422
Furniture and fixtures173,252166,915
Equipment543,869460,138
Construction in Progress42,82441,872
Leasehold improvements, property and equipment2,462,7612,317,290
Accumulated depreciation(1,083,507)(978,924)
Leasehold improvements, property and equipment, net$1,379,254$1,338,366

Accrued payroll and benefits were as follows:

December 31,
20182017
Workers' compensation liability$30,878$34,631
Accrued payroll35,62219,666
Other accrued payroll and benefits46,96728,244
Accrued payroll and benefits$113,467$82,541

Accrued liabilities were as follows:

December 31,
20182017
Transaction tax payable21,76218,920
Data security incident liability29,28930,000
Other accrued liabilities96,79846,759
Accrued liabilities$147,849$95,679
  1. Revenue Recognition

The gift card liability included in unearned revenue on the consolidated balance sheets is as follows:

December 31,
20182017
Gift card liability$70,474$63,645

Revenue recognized on the consolidated statements of income for the redemption of gift cards that were included in accrued liabilities at the beginning of the year is as follows:

Year ended December 31,
201820172016
Revenue recognized from gift card liability balance at the beginning of the year$36,094$37,109$32,744

We offered a limited-time frequency program called Chiptopia Summer Rewards during the third quarter of 2016, which allowed customers to redeem certain rewards earned through the first quarter of 2017. We deferred revenue reflecting the portion of the original rewards that were earned by program participants and not redeemed, and we recorded a corresponding liability on the consolidated balance sheet. The portion of revenue allocated to the rewards was based on the estimated standalone selling price of the award earned and took into consideration company-specific historical redemption patterns for similar promotions. Revenue was recognized as an award was redeemed, or upon expiration. During the twelve months ended December 31, 2017, we recognized $5,489 in revenue from the deferred liability for the loyalty rewards balance. No other material amounts related to loyalty rewards have been recognized in revenue for any periods presented.

  1. 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.

Our investments consist of U.S. treasury notes with maturities of up to one year. Fair value of investments is measured using Level 1 inputs. We designate the appropriate classification of our investments at the time of purchase based upon the intended holding period.

As of September 30, 2018, we transferred the classification of our investments from available-for-sale (“AFS”) to held-to-maturity (“HTM”) due to our ability and intent to hold these securities to maturity. The transfer from AFS to HTM was recorded at the fair value of the AFS securities at the time of transfer. The unrealized holding loss of $303, net of tax, at the date of transfer was retained in other comprehensive income (loss) on the consolidated statement of comprehensive income. Such amounts will be amortized to interest and other income on the consolidated statement of income over the remaining life of the securities. The amortization of this unrealized holding loss will be offset by the discount created as a result of this reclassification, which will also be amortized over the remaining life of the securities to interest and other income on the consolidated statement of income.

HTM securities are carried at amortized cost, which approximated fair value as of December 31, 2018. We recognize impairment charges when management believes the decline in the fair value of the investment is other-than-temporary. No impairment charges were recognized on our investments for the twelve months ended December 31, 2018. The fair value of our investments as of December 31, 2017, which were then classified as AFS, was $324,382, which included an unrealized loss of $493.

Realized gains and losses on AFS securities are recorded in interest and other income on the consolidated statement of income. We had no realized gains or losses for the years ended December 31, 2018 and 2017, and $547 of realized gains on AFS securities for the year ended December 31, 2016.

We have elected to fund certain deferred compensation obligations through a rabbi trust, the assets of which are designated as trading securities, as described further in Note 10. “Employee Benefit Plans.”

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Assets recognized or disclosed at fair value on the consolidated financial statements on a nonrecurring basis include items such as leasehold improvements, property and equipment, goodwill, and other intangible assets. These assets are measured at fair value if determined to be impaired.

Other than as disclosed in Note 5. “Corporate Restructuring Costs” and Note 6. “Restaurant Closure Costs and Impairment of Long-Lived Assets” as of December 31, 2018 and 2017, we had no non-financial assets or liabilities that were measured using Level 3 inputs.

  1. Corporate Restructuring Costs

In May 2018, we announced that we would open a headquarters office in Newport Beach, California, consolidate certain corporate administrative functions into our existing office in Columbus, Ohio, and close our existing headquarters offices in Denver, Colorado, as well as additional corporate offices in New York, New York. All affected employees were either offered an opportunity to continue in the new organization or were offered a severance package. We record severance as a one-time termination benefit and recognize the expense ratably over the employees’ required future service period. We record a liability for lease termination costs at the date we cease using property, consisting of the net present value of remaining lease obligations, net of estimated sublease rentals that could be reasonably obtained, and measure fair value using Level 3 inputs. Any subsequent adjustments to that liability as a result of lease termination or changes in estimates of sublease income are recorded in the period incurred. All other costs, including other employee transition costs, recruitment and relocation costs, other office closure costs, and third-party costs, are recognized in the period incurred.

Corporate restructuring costs consist of the following:

Year ended December 31,
2018
Employee severance and other employee transition costs(1)$6,919
Recruitment and relocation costs(1)9,952
Lease termination and other office closure costs(2)15,571
Third-party and other costs(1)8,836
Stock-based compensation(1)1,345
Total restructuring costs$42,623
(1)Recorded in general and administrative expenses on the consolidated statement of income.
(2)Recorded in impairment, closure costs, and asset disposals on the consolidated statement of income.

Changes in our restructuring liability which are included in accrued liabilities on the consolidated balance sheet were as follows:

Balance December 31, 2017ChargesPaymentsBalance December 31, 2018
Employee severance and other employee transition costs$-$6,919$(4,197)$2,722
Recruitment and relocation costs-9,952(9,728)224
Lease termination and other office closure costs-15,571-15,571
Third-party and other costs-8,836(8,282)554
Total restructuring liability$-$41,278$(22,207)$19,071
  1. Restaurant Closure Costs and Impairment of Long-Lived Assets

During the year ended December 31, 2018, we closed or relocated a total of 48 underperforming Chipotle restaurants, five Pizzeria Locale restaurants, and one TastyMade restaurant. As a result, we incurred lease termination, asset impairment and other closure costs, which were recorded in impairment, closure costs, and asset disposals on the consolidated statement of income as follows: 

Year ended December 31,
201820172016
Lease termination and other restaurant closure costs$40,522$3,284$17,394

Changes in our lease termination costs liability which is included in accrued liabilities on the consolidated balance sheet were as follows:

Balance December 31, 2017ChargesPaymentsBalance December 31, 2018
Lease termination costs for closed restaurants$1,416$13,843$(4,519)$10,740

In June 2018, we announced planned restaurant closures of approximately 55 to 65 restaurants beginning in the second quarter of 2018 and continuing over the next several quarters. As a part of this plan, and included in the total lease termination and other restaurant closure costs discussed above, we have closed or relocated 45 Chipotle restaurants and five Pizzeria Locale restaurants.

  1. Income Taxes

The components of the provision for income taxes are as follows:

Year ended December 31,
201820172016
Current tax:
U.S. Federal$58,878$98,208$20,765
U.S. State21,78018,6398,687
Foreign637669556
81,295117,51630,008
Deferred tax:
U.S. Federal10,541(16,201)(11,596)
U.S. State479(1,559)(2,546)
Foreign(2,261)(496)(2,470)
8,759(18,256)(16,612)
Valuation allowance1,8292302,405
Provision for income taxes$91,883$99,490$15,801

The effective tax rate differs from the statutory tax rates as follows:

Year ended December 31,
201820172016
Statutory U.S. federal income tax rate21.0%35.0%35.0%
State income tax, net of related federal income tax benefit6.64.413.3
Federal credits(2.1)(1.5)(10.1)
Executive compensation disallowed1.4--
Meals and entertainment0.1--
Enhanced deduction for food donation(0.1)(0.2)(2.4)
Valuation allowance0.70.16.0
Other3.51.56.2
Effects of the TCJA-(2.3)-
Return to provision and other discrete items1.1(0.9)(7.2)
Equity compensation related adjustments2.0--
Effective income tax rate34.2%36.1%40.8%

The 2018 annual effective tax rate was lower than the 2017 rate primarily due to the favorable impacts of the TCJA (as defined below) and federal tax credits offset by unfavorable tax impacts of expirations and cancellations of various equity awards.

The components of the deferred income tax assets and liabilities as of December 31, 2018 and 2017 for continuing operations are as follows:

December 31,
20182017
Deferred income tax liability:
Leasehold improvements, property and equipment$144,113$140,908
Goodwill and other assets1,4381,339
Prepaid assets and other4,1545,191
Total deferred income tax liability149,705147,438
Deferred income tax asset:
Deferred rent49,48142,859
Gift card liability5,7524,580
Capitalized transaction costs323324
Stock-based compensation and other employee benefits65,65180,447
Foreign net operating loss carry-forwards11,87111,376
State credits5,2305,589
Allowances, reserves and other13,35513,719
Valuation allowance(13,524)(12,270)
Total deferred income tax asset138,139146,624
Net deferred income tax liability$11,566$814

As of December 31, 2018, we have $1,530 of deferred tax assets related to outstanding non-vested stock awards that contain market conditions. If market conditions are not achieved, then we may not realize the benefit of these deferred tax assets, which would increase our effective tax rates in future periods.

As of December 31, 2018 and 2017, the gross foreign net operating losses were $54,599 and $50,292 as of December 31, 2018 and 2017, respectively.

As of December 31, 2018 and 2017, we had gross valuation allowances of approximately $63,509 and $54,675, respectively, against certain foreign deferred tax assets. The increase in the valuation allowance was primarily due to the recording of a valuation allowance on various foreign tax attributes.

Unrecognized Tax Benefits

A reconciliation of the unrecognized tax benefits is as follows:

Year ended December 31,
201820172016
Beginning of year$8,937$4,211$3,776
Increase resulting from current year tax position7514,726435
Lapsing of statutes of limitations(328)--
End of year$9,360$8,937$4,211

Interest expense related to uncertain tax positions is recognized in interest expense, and penalties related to uncertain tax positions are recognized in income tax expense. During the years ended December 31, 2018, 2017, and 2016, we recognized $536, $364, and $430, respectively, in interest expense related to uncertain tax positions. These balances are gross amounts before any tax benefits and are included in other liabilities in the accompanying consolidated balance sheets. We have accrued $1,329 and $794 for the payment of interest at December 31, 2018 and 2017, respectively.

We are no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2015. For the majority of states where we have a significant presence, we are no longer subject to tax examinations by tax authorities for tax years before 2015. Currently, we expect expirations of statutes of limitations, excluding indemnified amounts, on reserves of approximately $767 within the next twelve months.

It is reasonably possible the amount of the unrecognized benefit with respect to certain unrecognized positions could significantly increase or decrease within the next twelve months and would have an impact on net income.

Tax Cuts and Jobs Act

Effective for tax years beginning after December 31, 2017, the U.S. corporate income tax rate is 21% pursuant to the Tax Cuts and Jobs Act (“TCJA”), that was signed into law December 2017. As of December 31, 2018, we have completed our accounting for the tax effects of the TCJA and recorded cumulative tax adjustments of $6,446 in accordance with SAB 118 guidance.

In connection with the TCJA, a one-time transition tax is assessed on total post-1986 accumulated foreign earnings and profits that were previously deferred from U.S. income taxes, the amount of those earnings held in cash, and other specified assets and foreign tax pools. Based on our analysis of our total post-1986 accumulated foreign earnings and profits that were previously deferred from U.S. income taxes, the amount of those earnings held in cash, and other specified assets and foreign tax pools, we have determined a one-time transition tax of $0.

  1. Shareholders’ Equity

Through December 31, 2018, we had announced authorizations by our Board of Directors of repurchases of shares of common stock, which in the aggregate, authorized expenditures of up to $2.5 billion. On February 6, 2019, we announced that our Board of Directors authorized the repurchase of up to an additional $100,000 for repurchase of shares of common stock. Under the remaining repurchase authorizations, shares may be purchased from time to time in open market transactions, subject to market conditions.

As of December 31, 2018, $57,551 was available to be repurchased under previously-announced repurchase programs. Shares repurchased are being held in treasury stock until they are reissued or retired at the discretion of the Board of Directors.

During 2018, 2017, and 2016, shares of common stock were netted and surrendered as payment for minimum statutory tax withholding obligations in connection with the exercise and vesting of outstanding stock awards. We deem shares surrendered by the participants in accordance with the applicable award agreements and plan as repurchased, but do not deem such shares to be part of publicly announced share repurchase programs.

  1. Stock-Based Compensation

Pursuant to the 2011 Incentive Plan, we grant stock options, SOSARs, restricted stock units (“RSUs”), or performance/market based restricted stock units (“PSUs”) to employees and non-employee directors. We issue shares of common stock upon the exercise of SOSARs and the vesting of RSUs and PSUs.

Under the 2011 Incentive Plan, 6,830 shares of common stock have been authorized and reserved for issuance to eligible participants, of which 2,626 shares were authorized for issuance but not issued or subject to outstanding awards at December 31, 2018. For purposes of calculating the available shares remaining under the 2011 Incentive Plan, each share issuable pursuant to outstanding full value awards, such as RSUs and PSUs, counts as two shares, and each share underlying a stock option or SOSAR count as one share. The 2011 Incentive Plan is administered by the Compensation Committee of the Board of Directors, which has the authority to select the individuals to whom awards will be granted or to delegate its authority under the plan to make grants (subject to certain legal and regulatory restrictions), to determine the type of awards and when the awards are to be granted, the number of shares to be covered by each award, the vesting schedule and all other terms and conditions of the awards. The exercise price for stock awards granted under the 2011 Incentive Plan cannot be less than fair market value at the date of grant.

Stock-based compensation expense recognized in the consolidated financial statements was as follows:

Year ended December 31,
201820172016
Stock-based compensation expense$69,947$66,396$65,112
Stock-based compensation expense, net of tax$51,544$40,370$35,974
Stock-based compensation expense recognized as capitalized development$783$1,141$946
Excess tax benefit (deficit) on stock-based compensation recognized in provision for income taxes$(6,162)$448$-

SOSARs

SOSAR activity under the 2011 Stock Incentive Plan (in thousands, except years and per share data) was as follows:

201820172016
SharesWeighted-Average Exercise Price Per ShareSharesWeighted-Average Exercise Price Per ShareSharesWeighted-Average Exercise Price Per Share
Outstanding, beginning of year1,999$480.091,917$490.061,694$490.70
Granted741$396.66304$426.70460$457.77
Exercised(408)$353.98(35)$307.83(124)$315.87
Forfeited or cancelled(180)$489.14(187)$527.53(113)$559.25
Expired(1)$437.62-$--$-
Outstanding, end of year2,151$474.511,999$480.091,917$490.06
SharesWeighted-Average Exercise Price Per ShareWeighted-Average Remaining Years of Contractual LifeAggregate Intrinsic Value
Outstanding as of December 31, 20182,151$474.513.8$49,160
Vested and expected to vest as of December 31, 20182,107$476.093.7$47,427
Exercisable as of December 31, 20181,047$538.932.3$10,627

No SOSARs that included performance conditions were granted during 2018, 2017, or 2016, but in previous years, we granted SOSARs that included such conditions. As of December 31, 2018, 253 SOSARs with performance conditions were outstanding, and all were determined to have met the performance conditions.

The total intrinsic value of SOSARs exercised during the years ended December 31, 2018, 2017 and 2016 was $35,907, $4,296, and $15,946, respectively. Unrecognized stock-based compensation expense for SOSARs as of December 31, 2018 was $34,826 and is expected to be recognized over a weighted average period of 1.7 years.

The weighted average assumptions utilized in the Black-Scholes option-pricing model to estimate the fair value of SOSAR awards granted each year were as follows:

201820172016
Risk-free interest rate2.4%1.6%1.0%
Expected life (years)3.93.73.5
Expected dividend yield0.0%0.0%0.0%
Volatility32.2%29.9%32.2%
Weighted-average Black-Scholes fair value per share at date of grant$77.61$105.97$117.48

The risk-free interest rate is based on U.S. Treasury rates for instruments with similar terms, and the expected life assumption is based on our historical data. We have not paid dividends to date and do not plan to pay dividends in the near future. The volatility assumption is based on our historical data and implied volatility.

Non-Vested Stock Awards (RSUs)

A summary of non-vested stock award activity under the 2011 Stock Incentive Plan is as follows (in thousands, except per share data):

201820172016
SharesWeighted Average Grant Date Fair Value Per ShareSharesWeighted Average Grant Date Fair Value Per ShareSharesWeighted Average Grant Date Fair Value Per Share
Outstanding, beginning of year213$519.62125$606.24116$511.88
Granted141$305.00127$436.3690$509.05
Vested(39)$732.65(8)$454.84(7)$605.83
Forfeited or cancelled(91)$473.64(31)$502.46(74)$529.54
Expired-$--$--$-
Outstanding, end of year224$373.32213$519.62125$606.24

There were 141 non-vested stock awards with a weighted average grant date fair value per share of $305 that were vested and expected to vest as of December 31, 2018. Unrecognized stock-based compensation expense for non-vested stock awards we have determined are probable of vesting was $33,113 as of December 31, 2018, and is expected to be recognized over a weighted average period of 1.6 years. The fair value of shares earned as of the vesting date during the years ended December 31, 2018, 2017, and 2016 was $13,509, $3,524, and $2,787, respectively.

Non-Vested Performance Stock Awards (PSUs)

As of December 31, 2018, 70 of the outstanding non-vested stock awards were subject to performance and/or market conditions, in addition to service vesting conditions. During the year ended December 31, 2018, we awarded 29 performance shares that are subject to service and performance vesting conditions. The shares had a weighted-average grant date fair value was $328.74 per share and vest based on our growth in comparable restaurant sales and average restaurant margin over defined periods. 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 year ended December 31, 2017, we awarded 36 performance shares that are subject to service, market and performance vesting conditions. Two-thirds of the shares had a grant date fair value of $485.53 per share and have vesting criteria 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, with the quantity of shares that vest ranging from 0% to 350% of the targeted number of shares. The remaining one-third of the shares had a grant date fair value of $427.61 and have vesting criteria based on reaching certain comparable restaurant sales increases during the three-year period starting on January 1, 2017, with the quantity of shares that vest ranging 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 year ended December 31, 2016, we awarded 73 performance shares, net of cancellations, that are subject to both service and market vesting conditions. The quantity of shares that vest will range from 0% to 400% of a targeted number of shares, and will be determined 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. If the minimum defined stock price target is not met, then no shares will vest.

During the year ended December 31, 2018, 62 stock awards that were subject to service and performance or market conditions were forfeited.

We adjusted our estimates of the non-vested stock awards expected to vest, which had the following reduction on our expense and earnings per share (dollars in thousands, except per share data) in each of the following years:

Year ended December 31,
201820172016
Cumulative change in expense$(79)$(1,410)$(6,031)
Net of tax impact from cumulative change in expense$(58)$(857)$(3,332)
Impact on basic earnings per share$-$0.03$0.11
Impact on diluted earnings per share$-$0.03$0.11

No stock awards with market conditions were granted during the year ended December 31, 2018. Measurement of the grant date fair value of stock awards with market conditions in prior years included a Monte Carlo simulation model, which incorporates into the fair value determination the possibility that the market condition may not be satisfied, using the following assumptions:

201820172016
Risk-free interest rateN/A1.5%0.9%
Expected life (years)N/A3.03
Expected dividend yieldN/A0.0%0.0%
VolatilityN/A29.9%31.4%

The assumptions are based on the same factors as those described for SOSARs, except that the expected life is based on the contractual performance period for the stock awards.

In May 2018, as a result of the transition of employees in connection with the corporate restructuring described in Note 5. “Corporate Restructuring Costs”, we reduced our estimate of the number of certain SOSAR and RSU awards that we expect to vest, resulting in a cumulative adjustment to reduce expense of $5,360. In July 2018, we modified service requirements for certain SOSAR and RSU awards for approximately 340 employees, resulting in additional expense of approximately $6,900, of which $6,705 has been recognized during the year ended December 31, 2018. We expect to incur additional expense of $200 in 2019.

  1. Employee Benefit Plans

We maintain the Chipotle Mexican Grill 401(k) Plan (the “401(k) Plan”). We match 100% of the first 3% of pay contributed by each eligible employee and 50% on the next 2% of pay contributed. Employees become eligible to receive matching contributions after one year of service with Chipotle. For the years ended December 31, 2018, 2017, and 2016, matching contributions totaled approximately $6,090, $6,072 and $5,939, respectively.

We also maintain the Chipotle Mexican Grill, Inc. Supplemental Deferred Investment Plan (the “Deferred Plan”) which covers our eligible employees. The Deferred Plan is a non-qualified plan that allows participants to make tax-deferred contributions that cannot be made under the 401(k) Plan because of Internal Revenue Service limitations. Participants’ earnings on contributions made to the Deferred Plan fluctuate with the actual earnings and losses of a variety of available investment choices selected by the participant. Total liabilities under the Deferred Plan as of December 31, 2018 and 2017 were $10,872 and $19,887, respectively, and are included in other liabilities on the consolidated balance sheet. We match 100% of the first 3% of pay contributed by each eligible employee and 50% on the next 2% of pay contributed once the 401(k) contribution limits are reached. For the years ended December 31, 2018, 2017, and 2016, we made deferred compensation matches of $152, $199, and $225, respectively, to the Deferred Plan.

We have elected to fund our deferred compensation obligation through a rabbi trust. The rabbi trust is subject to creditor claims in the event of insolvency, but the assets held in the rabbi trust are not available for general corporate purposes. Amounts in the rabbi trust are invested in mutual funds, consistent with the investment choices selected by participants in their Deferred Plan accounts, which are designated as trading securities and carried at fair value, and are included in other assets on the consolidated balance sheet. Fair value of mutual funds is measured using Level 1 inputs (quoted prices for identical assets in active markets). The fair values of the investments in the rabbi trust were $10,872 and $19,887 as of December 31, 2018 and 2017, respectively. The realized and unrealized holding gains and losses related to these investments, as well as the offsetting deferred compensation expense, are recorded in general and administrative expenses on the consolidated statement of income.

We also offer an employee stock purchase plan (“ESPP”). Employees become eligible to participate after one year of service with Chipotle and may contribute up to 15% of their base earnings, subject to an annual maximum dollar amount, toward the monthly purchase of our common stock. The purchase price is 95% of the fair market value of the stock on the last trading date of the monthly exercise period. Under the ESPP, 250 shares of common stock have been authorized and reserved for issuances to eligible employees,

of which 246 represent shares that were authorized for issuance but not issued at December 31, 2018. For the years ended December 31, 2018, 2017, and 2016, the number of shares issued each year under the ESPP was less than 1.

  1. Leases

Our restaurants are primarily operated in leased premises. Lease terms for traditional shopping center or building leases generally include combined initial and option terms of 20-25 years. Ground leases generally include combined initial and option terms of 30-40 years. The option terms are typically in five-year increments. Typically, our leases include rent escalation terms every five years including fixed rent escalations, escalations based on inflation indexes, and fair market value adjustments. Certain leases contain contingent rental provisions that include a fixed base rent plus an additional percentage of the restaurant’s sales in excess of stipulated amounts. Our leases generally provide for the payment of common area maintenance, property taxes, insurance and various other use and occupancy costs. In addition, we are the lessee under leases covering certain offices.

Contractually required future minimum cash lease payments under existing operating leases as of December 31, 2018 are as follows:

2019$294,191
2020296,579
2021294,941
2022295,290
2023290,980
Thereafter2,478,397
Total minimum lease payments$3,950,378

Total minimum lease payments have not been reduced by minimum sublease rentals of $11,790 due in the future under our subleases. During fiscal 2018, 2017 and 2016, we recognized sublease income of $2,530, $2,214, and $2,074, respectively. Further, minimum lease payments include $90,484 of legally binding minimum lease payments for leases executed, but the lease term has not yet commenced.

Rental expense consists of the following:

Year ended December 31,
201820172016
Minimum rentals$294,854$278,812$255,955
Contingent rentals$2,714$2,317$1,811
Total$297,568$281,129$257,766

We have six sale and leaseback transactions. These transactions do not qualify for sale leaseback accounting because of our deemed continuing involvement with the buyer-lessor due to fixed price renewal options, which results in the transaction being recorded under the financing method. Under the financing method, the assets remain on the consolidated balance sheet and the proceeds from the transactions are recorded as a financing liability. A portion of lease payments are applied as payments of deemed principal and imputed interest. The deemed landlord financing liability was $2,390 and $2,630 as of December 31, 2018, and 2017, respectively, with the current portion of the liability included in accrued liabilities, and the remaining portion included in other liabilities in the consolidated balance sheet.

  1. Earnings Per Share

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

Year ended December 31,
201820172016
Net income$176,553$176,253$22,938
Shares:
Weighted-average number of common shares outstanding27,82328,49129,265
Dilutive stock awards13970505
Diluted weighted-average number of common shares outstanding27,96228,56129,770
Basic earnings per share$6.35$6.19$0.78
Diluted earnings per share$6.31$6.17$0.77

The following stock awards were excluded from the calculation of diluted EPS:

Year ended December 31,
201820172016
Stock awards subject to performance conditions95217263
Stock awards that were antidilutive1,7411,6951,316
Total stock awards excluded from diluted earnings per share1,8361,9121,579
  1. Commitments and Contingencies

Purchase Obligations

We enter into various purchase obligations in the ordinary course of business, generally of a short-term nature. Those that are binding primarily relate to commitments for food purchases and supplies, amounts owed under contractor and subcontractor agreements, orders submitted for equipment for restaurants under construction, and marketing initiatives and corporate sponsorships.

Litigation

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; however, we may incur legal expenses in excess of our insurance coverage limits associated with the data security incident in future periods. We will recognize these expenses as services are received.

As of December 31, 2018, we had a balance of $29,289 included in accrued liabilities on the consolidated balance sheet which represents an estimate of potential liabilities associated with anticipated claims and assessments by payment card networks in connection with the data security incident. We may ultimately be subject to liabilities greater than or less than the amount accrued.

Litigation Arising from Data 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. The Bellwether and Alcoa cases have been consolidated and will proceed as a single action. On October 24, 2018, the court issued an order granting in part and denying in part our motion to dismiss

the consolidated complaint, dismissing all claims other than those brought under state unfair competition laws in California and New Hampshire and plaintiffs’ request for declaratory relief. On December 10, 2018, the plaintiffs filed a second amended consolidated complaint, and on January 25, 2019 we filed a motion to dismiss the second amended complaint.

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 some customers to suffer alleged injuries and others to be at risk of possible future injuries. 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. Additionally, on August 21, 2017, Greg Lawson and Judy Conard filed a purported class action complaint in the U. S. District Court for the District of Colorado making allegations substantially similar to those in the Gordon complaint, and stating substantially similar claims as well as claims under the Colorado Consumer Protection Act. The Gordon and Lawson/Conard cases have been consolidated and will proceed as a single action. On September 26, 2018, the court issued an order granting in part, and denying in part, our motion to dismiss the consolidated complaint, including a dismissal of the negligence and unjust enrichment claims in their entirety.

We intend to continue 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 and the amounts included in accrued liabilities in relation to the data security incident.

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 required 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 an illness incident associated with a single Chipotle restaurant in Sterling, Virginia, and another follow-up subpoena on February 14, 2018 requesting information related to an illness incident associated with a single Chipotle restaurant in Los Angeles, California. 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 subpoenas were issued.

Shareholder Class Actions

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 Securities Exchange Act of 1934, as amended, 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. On March 22, 2018, the court granted our motion to dismiss, with prejudice. On April 20, 2018, the plaintiffs filed a motion for relief from the judgment and seeking leave to file a third amended complaint, and on November 20, 2018, the court denied the motion. On December 20, 2018, the plaintiff initiated an appeal to the U.S. Court of Appeals for the Second Circuit.

Additionally, on July 20, 2017, Elizabeth Kelley 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 filed a motion to dismiss the amended complaint on February 12, 2018, and a ruling on the motion remains pending.

We intend to continue to vigorously defend the Ong and Kelley cases, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from either of these 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.

  1. Quarterly Financial Data (Unaudited)

Summarized unaudited quarterly financial data:

2018
March 31June 30September 30December 31
Revenue$1,148,397$1,266,520$1,225,007$1,225,061
Operating income$92,808$67,957$57,991$39,612
Net income$59,446$46,884$38,204$32,019
Basic earnings per share$2.13$1.69$1.37$1.15
Diluted earnings per share$2.13$1.68$1.36$1.15
2017
March 31June 30September 30December 31
Revenue$1,068,829$1,169,409$1,128,074$1,110,100
Operating income$73,173$106,725$30,867$60,029
Net income$46,120$66,730$19,610$43,793
Basic earnings per share$1.60$2.33$0.69$1.56
Diluted earnings per share$1.60$2.32$0.69$1.55

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