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 Firm29
Consolidated Balance Sheets as of December 31, 2019 and 201832
Consolidated Statements of Income and Consolidated Statements of Comprehensive Income for the years ended December 31, 2019, 2018 and 201733
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2019, 2018 and 201734
Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018 and 201735
Notes to Consolidated Financial Statements36
Note 1 – Description of Business and Summary of Significant Accounting Policies36
Note 2 – Supplemental Balance Sheet Information43
Note 3 – Revenue Recognition43
Note 4 – Fair Value of Financial Instruments44
Note 5 – Corporate Restructuring Costs44
Note 6 – Restaurant Closure Costs45
Note 7 – Income Taxes46
Note 8 – Shareholders’ Equity48
Note 9 – Stock-Based Compensation48
Note 10 – Employee Benefit Plans51
Note 11 – Leases51
Note 12 – Earnings Per Share53
Note 13 – Commitments and Contingencies53
Note 14 – Quarterly Financial Data (Unaudited)55

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Report of Independent Registered Public Accounting Firm

To the Shareholders and the 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, 2019 and 2018, 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, 2019, 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, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.

We also have 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, 2019, 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 4, 2020 expressed an unqualified opinion thereon.

Adoption of New Accounting Standard

As discussed in Note 11 to the consolidated financial statements, the Company changed its method for accounting for leases in 2019. As explained below, auditing the Company’s valuation and accounting for leases was a critical audit matter.

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.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

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Valuation and accounting for leases
Description of the MatterAs described above and in Notes 1 and 11 to the consolidated financial statements, the Company adopted Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842)” (“ASC 842”) on January 1, 2019. In conjunction with the adoption of ASC 842, the Company evaluated the overall accounting implications, including review of contracts and vendor agreements to determine whether such agreements contained a lease. The Company determined its material operating leases consist of approximately 2,500 restaurant locations and office space. On the adoption date, the Company recorded $2.4 billion in operating lease assets and $2.7 billion in current and long-term operating lease liabilities on its consolidated balance sheet for existing operating leases. The calculation of the Company’s operating lease assets and liabilities include an estimate of the present value of future lease payments. Management estimated the Company’s incremental borrowing rates used in its present value calculation which required subjectivity. The incremental borrowing rate is the rate of interest that the lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Auditing management’s contract evaluation performed in conjunction with the adoption of ASC 842 was complex and required judgment to analyze the terms within the contracts and vendor agreements to determine whether we concurred with management’s evaluation. Additionally, during the inspection of contracts and vendor agreements and analysis of contractual terms, inquiries and discussions were held outside of the accounting department to support the evaluation. Further, auditing management’s assessment of its incremental borrowing rate is especially subjective and judgmental as the Company has no outstanding debt nor committed credit facilities, secured or otherwise that would have comparable collateral or similar terms as their underlying restaurant locations and office space.
How We Addressed the Matter in Our AuditWe obtained an understanding, evaluated the design, and tested the operating effectiveness of management’s controls over the implementation of the ASC 842 process, including the Company’s controls with regards to the contract evaluation, and review of the methodology, inputs, and assumptions used to determine the incremental borrowing rate. Our substantive audit procedures included, among others, involving specialists to assist in evaluating management’s methodology and assumptions used to determine the Company’s incremental borrowing rate at the date of adoption of ASC 842. The considerations to determine the appropriateness of the Company’s incremental borrowing rate included the Company’s credit rating, current market environment for recent debt transactions, and market data available to support the adjustment required to reflect a collateralized borrowing rate. In addition, we obtained and inspected a sample of individual leases to test the completeness and accuracy of the lease inputs and terms used in the Company’s calculation and tested the computational accuracy. We additionally performed procedures to determine the completeness of the lease population used in the Company’s analysis. We tested a sample of contracts and vendor agreements to determine whether management appropriately evaluated whether such agreements contained a lease. These procedures included, among others, inspecting contracts and vendor agreements, analyzing contractual terms and performing inquiries within the organization outside of the accounting department. Additionally, our procedures included reviewing management’s lease questionnaires sent to relevant employees and cash disbursement listings to test that contracts which could contain lease provisions were considered in the lease population used in the Company’s analysis. We also evaluated the Company’s lease disclosures included in Notes 1 and 11 in relation to these matters.

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Valuation and accounting for stock-based compensation
Description of the MatterThe Company incurred $92.1 million in stock-based compensation expense during the year ended December 31, 2019. Approximately 227,000 of the Company’s non-vested stock awards were subject to service and performance conditions during the year ended December 31, 2019. As described in Notes 1 and 9 to the consolidated financial statements, the Company estimates the grant date fair value of the stock awards and expenses the fair value of stock awards subject to service conditions over the respective vesting period. Stock-based compensation expense of stock awards subject to performance conditions is based on the estimated probability of achieving levels of performance associated with particular levels of payout. Additionally, at each reporting period, the Company evaluates the probable outcome of the performance conditions including consideration of significant assumptions and as applicable, recognizes the cumulative effect of the change in estimate in the period of the change. Auditing the grant date fair value and the appropriateness of the accounting treatment of the Company’s stock awards was complex and judgmental. In particular, the fair value estimate for stock awards subject to performance conditions is sensitive to significant assumptions including management’s internal estimates of the Company’s future performance.
How We Addressed the Matter in Our AuditWe obtained an understanding, evaluated the design, and tested the operating effectiveness of management’s controls over stock-based compensation. We tested controls over management’s review of the valuation model methodology and assumptions used with regards to the service and performance conditions. We also tested management's controls to validate that data used in the valuation model was complete and accurate. Our substantive audit procedures included, among others, testing the significant assumptions underlying the performance conditions (e.g., certain targets related to growth in comparable restaurant sales and average restaurant margin) and testing the completeness and accuracy of the underlying data. We evaluated management’s significant assumptions by comparing the assumptions to current market and economic trends, historical results of the Company’s business, and to other relevant factors. We additionally performed a sensitivity analysis of the significant assumptions to evaluate the change in the fair value of the stock awards subject to performance conditions resulting from changes in the assumptions. We also evaluated the adequacy of the Company’s stock-based compensation disclosures included in Notes 1 and 9 in relation to these matters.

/s/ Ernst & Young LLP

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

Irvine, California

February 4, 2020

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

December 31,
20192018
Assets
Current assets:
Cash and cash equivalents$480,626$249,953
Accounts receivable, net80,54562,312
Inventory26,09621,555
Prepaid expenses and other current assets57,07654,129
Income tax receivable27,705-
Investments400,156426,845
Total current assets1,072,204814,794
Leasehold improvements, property and equipment, net1,458,6901,379,254
Restricted cash27,85530,199
Operating lease assets2,505,466-
Other assets18,45019,332
Goodwill21,93921,939
Total assets$5,104,604$2,265,518
Liabilities and shareholders' equity
Current liabilities:
Accounts payable$115,816$113,071
Accrued payroll and benefits126,600113,467
Accrued liabilities155,843147,849
Unearned revenue95,19570,474
Current operating lease liabilities173,139-
Income tax payable-5,129
Total current liabilities666,593449,990
Commitments and contingencies (Note 13)
Deferred rent-330,985
Long-term operating lease liabilities2,678,374-
Deferred income tax liabilities37,81411,566
Other liabilities38,79731,638
Total liabilities3,421,578824,179
Shareholders' equity:
Preferred stock, $0.01 par value, 600,000 shares authorized, no shares issued as of December 31, 2019 and 2018, respectively--
Common stock, $0.01 par value, 230,000 shares authorized, 36,323 and 35,973 shares issued as of December 31, 2019 and 2018, respectively363360
Additional paid-in capital1,465,6971,374,154
Treasury stock, at cost, 8,568 and 8,276 common shares as of December 31, 2019 and 2018, respectively(2,699,119)(2,500,556)
Accumulated other comprehensive loss(5,363)(6,236)
Retained earnings2,921,4482,573,617
Total shareholders' equity1,683,0261,441,339
Total liabilities and shareholders' equity$5,104,604$2,265,518

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

Year ended December 31,
201920182017
Revenue$5,586,369$4,864,985$4,476,412
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
Food, beverage and packaging1,847,9161,600,7601,535,428
Labor1,472,0601,326,0791,205,992
Occupancy363,072347,123327,132
Other operating costs760,831680,031651,644
General and administrative expenses451,552375,460296,388
Depreciation and amortization212,778201,979163,348
Pre-opening costs11,1088,54612,341
Impairment, closure costs, and asset disposals23,09466,63913,345
Total operating expenses5,142,4114,606,6174,205,618
Income from operations443,958258,368270,794
Interest and other income, net14,32710,0684,949
Income before income taxes458,285268,436275,743
Provision for income taxes(108,127)(91,883)(99,490)
Net income$350,158$176,553$176,253
Earnings per share:
Basic$12.62$6.35$6.19
Diluted$12.38$6.31$6.17
Weighted-average common shares outstanding:
Basic27,74027,82328,491
Diluted28,29527,96228,561

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

Year ended December 31,
201920182017
Net income$350,158$176,553$176,253
Other comprehensive income (loss), net of income taxes:
Foreign currency translation adjustments726(2,736)4,689
Unrealized gain (loss) on available-for-sale securities, net of income taxes147159(186)
Other comprehensive income (loss), net of income taxes873(2,577)4,503
Comprehensive income$351,031$173,976$180,756

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands)

Common StockTreasury StockAccumulated Other Comprehensive Income (Loss)
SharesAmountAdditional‎Paid-In‎CapitalSharesAmountRetained‎EarningsAvailable-for-Sale SecuritiesForeign Currency TranslationTotal
Balance, December 31, 201635,833$358$1,238,8757,019$(2,049,389)$2,220,811$(120)$(8,042)$1,402,493
Stock-based compensation--66,396-----66,396
Stock plan transactions and other191(181)-----(180)
Acquisition of treasury stock---807(285,020)---(285,020)
Net income-----176,253--176,253
Other comprehensive income (loss), net of income taxes------(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 compensation--69,947-----69,947
Stock plan transactions and other1211(883)-----(882)
Acquisition of treasury stock---450(166,147)---(166,147)
Net income-----176,553--176,553
Other comprehensive income (loss), net of income taxes------159(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
Adoption of ASU No. 2016-02, Leases (Topic 842)-----(2,327)--(2,327)
Stock-based compensation--92,062-----92,062
Stock plan transactions and other3503(519)-----(516)
Acquisition of treasury stock---292(198,563)---(198,563)
Net income-----350,158--350,158
Other comprehensive income (loss), net of income taxes------147726873
Balance, December 31, 201936,323$363$1,465,6978,568$(2,699,119)$2,921,448$-$(5,363)$1,683,026

See accompanying notes to consolidated financial statements.

CHIPOTLE MEXICAN GRILL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

Year ended December 31,
201920182017
Operating activities
Net income$350,158$176,553$176,253
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization212,778201,979163,348
Amortization of operating lease assets163,952--
Deferred income tax (benefit) provision29,96210,585(18,026)
Impairment, closure costs, and asset disposals15,40261,98713,345
Bad debt allowance33125214
Stock-based compensation expense91,39669,16465,255
Other(10,592)(2,918)(218)
Changes in operating assets and liabilities:
Accounts receivable(2,630)(8,298)(140)
Inventory(4,530)(1,722)(5,250)
Prepaid expenses and other current assets(23,066)(3,811)(6,710)
Other assets2,818(2,005)(1,476)
Accounts payable(973)32,08010,908
Accrued payroll and benefits11,75929,5686,188
Accrued liabilities36,54314,83128,179
Unearned revenue30,4006,8294,207
Income tax payable/receivable(32,083)14,439(4,173)
Deferred rent-21,29729,996
Operating lease liabilities(151,557)--
Other long-term liabilities1,8628696,316
Net cash provided by operating activities721,632621,552468,216
Investing activities
Purchases of leasehold improvements, property and equipment(333,912)(287,390)(216,777)
Purchases of investments(448,754)(485,188)(199,801)
Maturities of investments476,723385,000330,000
Proceeds from sale of equipment13,969--
Net cash used in investing activities(291,974)(387,578)(86,578)
Financing activities
Acquisition of treasury stock(190,617)(160,937)(285,218)
Tax withholding on stock-based compensation awards(10,420)(5,411)(702)
Stock plan transactions and other financing activities(698)(187)26
Net cash used in financing activities(201,735)(166,535)(285,894)
Effect of exchange rate changes on cash, cash equivalents and restricted cash406(1,457)2,056
Net change in cash, cash equivalents, and restricted cash228,32965,98297,800
Cash, cash equivalents, and restricted cash at beginning of period280,152214,170116,370
Cash, cash equivalents, and restricted cash at end of period$508,481$280,152$214,170
Supplemental disclosures of cash flow information
Income taxes paid$109,571$67,053$119,787
Purchases of leasehold improvements, property, and equipment accrued in accounts payable and accrued liabilities$36,886$30,870$31,806
Acquisition of treasury stock accrued in accounts payable and accrued liabilities$-$2,474$2,274

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, 2019, we operated 2,580 Chipotle restaurants throughout the United States as well as 39 international Chipotle restaurants. We are also an investor in a consolidated entity that owns and operates three Pizzeria Locale restaurants, a fast-casual pizza concept. We manage our operations based on eight regions and have aggregated our operations to 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.

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 $7 and $0 as of December 31, 2019 and 2018, 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 statements 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), net of income taxes on the consolidated statements 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 statements of income when management believes the decline in the fair value of the investment is other-than-temporary.

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, 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 monthly using average monthly exchange rates. Resulting translation adjustments are recorded as a separate component of other comprehensive income (loss), net of income taxes on the consolidated statement of comprehensive income.

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. During the years ended December 31, 2019, 2018 and 2017, we capitalized $6,735, $6,285, and $7,507 of internal cost, respectively. Expenditures for refurbishments and improvements that significantly add to the productivity capacity or extend the useful life are capitalized, while expenditures for 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 certain, 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 impairment, closure costs, and asset disposals in the consolidated statements of income. Assets to be disposed of are reported at the lower of their carrying amount or fair value less estimated costs to sell.

At least annually, or when impairment indicators are present, 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

Leases

We determine if a contract contains a lease at inception. Our material operating leases consist of restaurant locations and office space. Our leases generally have remaining terms of 1-20 years and most include options to extend the leases for additional 5-year periods. Generally, the lease term is the minimum of the noncancelable period of the lease or the lease term inclusive of reasonably certain renewal periods up to a term of 20 years.

Operating lease assets and liabilities are recognized at the lease commencement date, which is the date we take possession of the property. Operating lease liabilities represent the present value of lease payments not yet paid. Operating lease assets represent our right to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment of operating lease assets. To determine the present value of lease payments not yet paid, we estimate incremental borrowing rates corresponding to the lease term including reasonably certain renewal periods. As we have no outstanding debt nor committed credit facilities, secured or otherwise, we estimate this rate based on prevailing financial market conditions, comparable company and credit analysis, and management judgment.

Our leases typically contain rent escalations over the lease term. We recognize expense for these leases on a straight-line basis over the lease term. Additionally, tenant incentives used to fund leasehold improvements are recognized when earned and reduce our right-of-use asset related to the lease. These are amortized through the operating lease asset as reductions of expense over the lease term.

Some of our leases include rent 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, generally in excess of a stipulated amount. Operating lease liabilities are calculated using the prevailing index or rate at lease commencement. Subsequent escalations in the index or rate and contingent rental payments are recognized as variable lease expenses. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Goodwill

Goodwill is not subject to amortization, but instead is tested for impairment at least annually, or when impairment indicators are present, 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, 2019, 2018, and 2017.

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 and rental deposits related to leased properties.

Insurance Liability

We are self-insured for a significant portion of our employee health benefits programs, and carry significant retentions for risks and associated liabilities with respect to workers’ compensation, general liability, property and auto damage, employment practices liability, cyber liability and directors and officer’s liability. 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.

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 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 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 reserve in the period in which it arises. We adjust our unrecognized tax benefit liability and provision for income taxes 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 statements of income. Accrued interest and penalties are included within the related tax reserve on our consolidated balance sheets.

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 remit to governmental taxing authorities.

Delivery

We offer our customers delivery in almost all of our geographic regions. Delivery services are fulfilled by third-party service providers. In some cases, we make delivery sales through our website 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 mobile 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 collected by the delivery partner, when control of the food is transferred to the delivery partner. We receive payment from the delivery partner subsequent to the transfer of food and the payment terms 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. Gift card balances are initially recorded as unearned revenue. We recognize revenue from gift cards when the gift card is redeemed by the customer. Historically, the majority of gift cards are redeemed within one year. In addition, based on historical redemption rates, a portion of gift cards are not expected to be redeemed and will be recognized as breakage over time in proportion to gift card redemptions. The breakage rates are based on company and program specific information, including historical redemption patterns, and expected remittance to government agencies under unclaimed property laws, if applicable. We evaluate our breakage rate estimate annually and apply that rate to gift card redemptions. 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

During the first quarter of 2019, we launched Chipotle Rewards nationally. 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 vouchers (“Bonus Vouchers”). Earned rewards generally expire one to two 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 standalone selling price of points or Bonus Vouchers earned by customers as each point or Bonus Voucher is earned, net of points we do not expect to be redeemed. The estimated standalone selling price of each point or Bonus Voucher earned is based on the estimated value of product for which the reward is expected to be redeemed. Our estimate of points and Bonus Vouchers we expect to be redeemed is based on historical company specific data. The cost associated with rewards and Bonus Vouchers are recorded when they are redeemed and are included in food, beverage, and packaging expense on our consolidated statements of income.

We recognize loyalty revenue on the consolidated statements of income when a customer redeems an earned reward. Deferred revenue associated with Chipotle Rewards is included in unearned revenue on our consolidated balance sheets.

Advertising and Marketing Costs

Advertising and marketing costs are expensed as incurred and totaled $141,567, and $111,695 and $106,345 for the years ended December 31, 2019, 2018 and 2017, respectively. Advertising and marketing costs are included in other operating costs on the consolidated statements of income.

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 sheets.

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 statements of income.

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” above for a description of level inputs. We first compare the carrying value of the asset (or asset group, referred interchangeably throughout as 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 the income approach to measure the fair value,

which is based on the present value of estimated future cash flows. Key inputs to the income approach for restaurant assets include the discount rate, projected restaurant cash flows, and sublease income if we are closing the restaurant. 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 and are allocated among the long-lived asset or assets of the group.

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 June 2016, the Financial Accounting Standards Board “FASB” issued Accounting Standards Update “ASU” 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We will adopt the standard effective January 1, 2020. We do not expect the adoption of ASU 2016-13 to result in a material change to our consolidated financial statements.

In August 2018, the FASB issued ASU 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 (“ASU 2018-15”), which clarifies the accounting for implementation costs in cloud computing arrangements. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We will adopt the standard prospectively on January 1, 2020. Prior to the adoption of ASU 2018-15, we capitalized implementation costs incurred during the application development phase of cloud computing arrangements to leasehold improvements, property and equipment, net on our consolidated balance sheets and have recognized expense over the useful life of the related asset within depreciation and amortization on our consolidated statements of income. Subsequent to the adoption of ASU 2018-15, we will capitalize such costs within prepaid expenses and other current assets or other assets on our consolidated balance sheets and will recognize expense within general and administrative expenses or other operating costs on our consolidated statements of income, consistent with the where the expense associated with the hosting element of the arrangement are presented. We do not expect the adoption of ASU 2018-15 to result in a material change to our consolidated financial statements.

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 Standards

On January 1, 2019, we adopted ASU 2016-02, “Leases (Topic 842),” along with related clarifications and improvements. This pronouncement requires lessees to recognize a liability for lease obligations, which represents the discounted obligation to make future lease payments, and a corresponding right-of-use asset on the consolidated balance sheets. 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 elected the optional transition method to apply the standard as of the effective date and therefore, we have not applied the standard to the comparative periods presented on our consolidated financial statements.

Our practical expedients were as follows:

Implications as of January 1, 2019
Practical expedient packageWe have not reassessed whether any expired or existing contracts are, or contain, leases.
We have not reassessed the lease classification for any expired or existing leases.
We have not reassessed initial direct costs for any expired or existing leases.
Hindsight practical expedientWe have not elected the hindsight practical expedient, which permits the use of hindsight when determining lease term and impairment of operating lease assets.

The impact on the consolidated balance sheet is as follows:

December 31, 2018Adjustments Due to the Adoption of Topic 842January 1, 2019
Assets
Current assets:
Cash and cash equivalents$249,953$-$249,953
Accounts receivable62,312-62,312
Inventory21,555-21,555
Prepaid expenses and other current assets54,129(23,653)30,476
Investments426,845-426,845
Total current assets814,794(23,653)791,141
Leasehold improvements, property and equipment, net1,379,254(15,167)1,364,087
Restricted cash30,199-30,199
Operating lease assets-2,363,0202,363,020
Other assets19,332-19,332
Goodwill21,939-21,939
Total assets$2,265,518$2,324,200$4,589,718
Liabilities and shareholders' equity
Current liabilities:
Accounts payable$113,071$-$113,071
Accrued payroll and benefits113,467-113,467
Accrued liabilities147,849(23,860)123,989
Unearned revenue70,474-70,474
Income tax payable5,129-5,129
Total current liabilities449,990(23,860)426,130
Commitments and contingencies
Deferred rent330,985(330,985)-
Current and long-term operating lease liabilities-2,682,2032,682,203
Deferred income tax liabilities11,566(831)10,735
Other liabilities31,638-31,638
Total liabilities824,1792,326,5273,150,706
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, respectively360-360
Additional paid-in capital1,374,154-1,374,154
Treasury stock, at cost, 8,276 and 7,826 common shares at December 31, 2018 and 2017, respectively(2,500,556)-(2,500,556)
Accumulated other comprehensive loss(6,236)-(6,236)
Retained earnings2,573,617(2,327)2,571,290
Total shareholders' equity1,441,339(2,327)1,439,012
Total liabilities and shareholders' equity$2,265,518$2,324,200$4,589,718

2. Supplemental Balance Sheet Information

Leasehold improvements, property and equipment, net were as follows:

December 31,
20192018
Land$12,943$12,943
Leasehold improvements and buildings1,765,4641,689,873
Furniture and fixtures182,391173,252
Equipment653,909543,869
Construction in Progress45,42242,824
Leasehold improvements, property and equipment2,660,1292,462,761
Accumulated depreciation(1,201,439)(1,083,507)
Leasehold improvements, property and equipment, net$1,458,690$1,379,254

Accrued payroll and benefits were as follows:

December 31,
20192018
Workers' compensation liability$29,837$30,878
Accrued payroll31,18835,622
Other accrued payroll and benefits65,57546,967
Accrued payroll and benefits$126,600$113,467

Accrued liabilities were as follows:

December 31,
20192018
Sales and Use tax payable$26,484$21,762
Legal reserve liability45,7214,661
Data security incident liability15,00029,289
Other accrued liabilities68,63892,137
Accrued liabilities$155,843$147,849

3. Revenue Recognition

Gift Cards

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

December 31,
20192018
Gift card liability$84,611$70,474

Revenue recognized from the redemption of gift cards that was included in unearned revenue at the beginning of the year was as follows:

Year ended December 31,
201920182017
Revenue recognized from gift card liability balance at the beginning of the year$37,386$36,094$37,109

Chipotle Rewards

Chipotle Rewards launched nationally in March 2019. Accordingly, there was no revenue recognized from unearned revenue associated with this loyalty program in the years ended December, 2018 or 2017. Changes in our Chipotle Rewards liability included in unearned revenue on the consolidated balance sheets were as follows:

Year ended
December 31,
2019
Chipotle Rewards liability, beginning balance$-
Revenue deferred44,666
Revenue recognized(34,082)
Chipotle Rewards liability, ending balance$10,584

4**. Fair Value of Financial I****nstruments**

Assets and Liabilities Measured at Fair Value on a Recurring Basis

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.

Investments, all of which are classified as held-to-maturity (“HTM”), are carried at amortized cost and approximated fair value as of December 31, 2019. We recognize impairment charges when management believes the decline in the fair value of the investment below the carrying value is other-than-temporary. No impairment charges were recognized on our investments for the twelve months ended December 31, 2019 and 2018.

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, operating lease assets, 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”, Note 6. “Restaurant Closure Costs” and Note 11. “Leases” as of December 31, 2019 and 2018, we had no material non-financial assets or liabilities that were measured using Level 3 inputs.

5. 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.

All other costs, including other employee transition costs, recruitment and relocation costs, office asset impairment and other office closure costs, and third-party and other costs, are recognized in the period incurred.

Corporate restructuring costs consist of the following:

Year ended December 31,
201920182017
Employee severance and other employee transition costs(1)$1,768$6,919$-
Recruitment and relocation costs(1)6,2319,952-
Office asset impairment and other office closure costs(2)1,71915,571-
Third-party and other costs(1)4,3248,836-
Stock-based compensation(1)1341,345-
Total corporate restructuring costs$14,176$42,623$-

(1)Recorded in general and administrative expenses on the consolidated statements of income.

(2)Recorded in impairment, closure costs, and asset disposals on the consolidated statements of income.

Upon the adoption of Topic 842 on January 1, 2019, lease termination and other closure liabilities of $14,716 were reclassified into operating lease assets and are no longer within the scope of ASC 420, Exit or Disposal Cost Obligations.

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

December 31, 2018ChargesPaymentsDecember 31, 2019
Employee severance and other employee transition costs$2,722$1,768$(4,490)$-
Recruitment and relocation costs2246,231(6,425)30
Third-party and other costs5544,324(4,878)-
Total restructuring liability$3,500$12,323$(15,793)$30

6. Restaurant Closure Costs

During the year ended December 31, 2019, 2018, and 2017, we closed or relocated underperforming restaurants totaling nine, 54, and 25, respectively. This included the planned restaurant closures announced in June 2018. In connection with this initiative, we have closed or relocated 56 restaurants, of which six of these closures were in 2019. In total, we incurred restaurant asset impairment and other restaurant closure costs, which were recorded in impairment, closure costs, and asset disposals on the consolidated statements of income as follows: 

Year ended December 31,
201920182017
Restaurant asset impairment and other restaurant closure costs$2,997$40,522$3,284

Upon the adoption of Topic 842 on January 1, 2019, lease termination and other closure liabilities of $9,144 were reclassified into operating lease assets and are no longer within the scope of ASC 420, Exit or Disposal Cost Obligations.

7. Income Taxes

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

Year ended December 31,
201920182017
Current tax:
U.S. Federal$57,020$58,878$98,208
U.S. State20,49921,78018,639
Foreign646637669
78,16581,295117,516
Deferred tax:
U.S. Federal27,23110,541(16,201)
U.S. State2,740479(1,559)
Foreign(2,685)(2,261)(496)
27,2868,759(18,256)
Valuation allowance2,6761,829230
Provision for income taxes$108,127$91,883$99,490

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

Year ended December 31,
201920182017
Statutory U.S. federal income tax rate21.0%21.0%35.0%
State income tax, net of related federal income tax benefit4.16.64.4
Federal credits(1.7)(2.1)(1.5)
Executive compensation disallowed2.01.4-
Meals and entertainment0.10.1-
Enhanced deduction for food donation-(0.1)(0.2)
Valuation allowance0.50.70.1
Other0.83.51.5
Effects of the TCJA--(2.3)
Return to provision and other discrete items0.11.1(0.9)
Equity compensation related adjustments(3.3)2.0-
Effective income tax rate23.6%34.2%36.1%

The effective tax rate for the year ended December 31, 2019, was lower than the effective tax rate for the year ended December 31, 2018, primarily due to net excess benefits from stock-based compensation and net year over year decrease in tax expense related to equity award expirations, partially offset by current year increases in non-deductible executive compensation.

The components of the deferred income tax assets and liabilities for continuing operations were as follows:

December 31,
20192018
Deferred income tax liability:
Leasehold improvements, property and equipment$162,291$144,113
Goodwill and other assets1,5371,438
Prepaid assets and other1,2904,154
Operating lease asset686,333-
Total deferred income tax liability851,451149,705
Deferred income tax asset:
Deferred rent-49,481
Gift card liability6,1855,752
Capitalized transaction costs323323
Stock-based compensation and other employee benefits41,27065,651
Foreign net operating loss carry-forwards13,79611,871
State credits4,1705,230
Operating lease liability741,120-
Allowances, reserves and other22,97313,355
Valuation allowance(16,200)(13,524)
Total deferred income tax asset813,637138,139
Deferred income tax liabilities$37,814$11,566

As of December 31, 2019, we no longer have deferred tax assets related to outstanding non-vested stock awards that contain market conditions.

Gross foreign net operating losses were $68,169 and $54,599 as of December 31, 2019 and 2018, respectively.

We had gross valuation allowances against certain foreign deferred tax assets of $77,191 and $63,509 as of December 31, 2019 and 2018, respectively. 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 was as follows:

Year ended December 31,
201920182017
Beginning of year$9,360$8,937$4,211
Increase resulting from prior year tax position5,855--
Increase resulting from current year tax position7587514,726
Settlements with taxing authorities(736)--
Lapsing of statutes of limitations(209)(328)-
End of year$15,028$9,360$8,937

Interest expense related to uncertain tax positions is recognized in interest expense on the consolidated statements of income. Penalties related to uncertain tax positions are recognized in income tax expense on the consolidated statements of income. During the years ended December 31, 2019, 2018, and 2017, we recognized $1,853, $536, and $364, 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 accrued $3,054 and $1,329 for the payment of interest at December 31, 2019 and 2018, respectively.

We are no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2016. 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 2016. Currently, we expect expirations of statutes of limitations, excluding indemnified amounts, on reserves of approximately $202 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 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 for the year ended December 31, 2017.

8. Shareholders’ Equity

We have had a stock repurchase program in place since 2008 and, through December 31, 2019 we have repurchased shares with a total value of $2.6 billion. As of December 31, 2019, $69,417 was available to be repurchased under announced repurchase authorizations, which does not include an additional $100,000 that was authorized by our Board of Directors in December 2019 but not announced until February 4, 2020. Shares repurchased are being held in treasury stock until they are reissued or retired at the discretion of the Board of Directors.

During the years ended December 31, 2019, 2018, and 2017, shares of common stock at total costs of $10,420, $5,411, and $702, respectively, were netted and surrendered as payment for minimum statutory withholding obligations in connection with the vesting of outstanding stock awards. Shares surrendered by the participants in accordance with the applicable award agreements and plan are deemed repurchased by us but are not part of publicly announced share repurchase programs.

9. Stock-Based Compensation

Pursuant to the 2011 Incentive Plan, we grant stock options, SOSARs, restricted stock units (“RSUs”), or performance and/or 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 2,321 shares were authorized for issuance but not issued or subject to outstanding awards as of December 31, 2019. 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 and 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,
201920182017
Stock-based compensation$92,062$69,947$66,396
Stock-based compensation, net of income taxes$73,866$51,544$40,370
Total capitalized stock-based compensation included in net leasehold improvements, property and equipment on the consolidated balance sheets$666$783$1,141
Excess tax benefit (deficit) on stock-based compensation recognized in provision for income taxes$16,203$(6,162)$448

SOSARs

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

SharesWeighted-Average Exercise Price per ShareWeighted-Average Remaining Contractual Life (Years)Aggregate Intrinsic Value
Outstanding, January 1, 20192,151$474.51$49,160
Granted201601.59
Exercised(1,130)510.35
Forfeited or cancelled(40)483.11
Expired(50)559.29
Outstanding, December 31, 20191,132457.144.4430,270
Exercisable, December 31, 2019365505.352.4121,242
Vested and expected to vest, December 31, 20191,095454.764.3418,815

The total intrinsic value of SOSARs exercised during the years ended December 31, 2019, 2018 and 2017, was $219,984, $35,907, and $4,296, respectively. Unrecognized stock-based compensation expense for SOSARs as of December 31, 2019 was $30,338 and is expected to be recognized over a weighted average period of 1.5 years.

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

201920182017
Risk-free interest rate2.4%2.4%1.6%
Expected life (years)3.93.93.7
Expected dividend yield0.0%0.0%0.0%
Volatility34.7%32.2%29.9%
Weighted-average Black-Scholes fair value per share at date of grant$176.79$77.61$105.97

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

SharesWeighted-Average Grant Date Fair Value per Share
Outstanding, January 1, 2019154$352.85
Granted28627.94
Vested(46)388.08
Forfeited or cancelled(15)303.84
Outstanding, December 31, 2019121408.56
Vested and expected to vest, December 31, 2019113401.74

The weighted average grant date fair value per RSU granted during the years ended December 31, 2018 and 2017, was $299.25 and $414.36, respectively. Unrecognized stock-based compensation expense for non-vested RSU stock awards we have determined are probable of vesting was $14,803 as of December 31, 2019, and is expected to be recognized over a weighted average period of 1.4 years. The fair value of shares earned as of the vesting date during the years ended December 31, 2019, 2018, and 2017, was $27,197, $4,192, and $3,524, respectively.

Non-Vested Performance Stock Awards (PSUs)

A summary of non-vested PSU award activity under the 2011 Stock Incentive Plan was as follows:

SharesWeighted-Average Grant Date Fair Value per Share
Outstanding, January 1, 201970$418.52
Granted46583.13
Vested--
Expired(13)518.62
Outstanding, December 31, 2019103479.83
Vested and expected to vest, December 31, 2019227479.61

The weighted average fair value per PSU granted during the years ended December 31, 2018 and 2017, was $327.58 and $466.29, respectively. The Unrecognized stock-based compensation expense for non-vested PSU stock awards we have determined are probable of vesting was $60,921 as of December 31, 2019, and is expected to be recognized over a weighted average period of 2.2 years. The fair value of shares earned as of the vesting date during the years ended December 31, 2019, 2018, and 2017, was $0, $9,317, and $0, respectively.

During the year ended December 31, 2019, we awarded two types of performance share awards that are subject to service and performance vesting conditions. The quantity of shares that will vest range from 0% to 300% of the targeted number of shares for both awards. The first award, consisting of 33 shares, will vest based on our growth in comparable restaurant sales and average restaurant margin over a three-year period beginning on January 1, 2019. The second award, consisting of 13 shares, will vest based on achievement of certain targets related to digital sales, general and administrative expenses as a percentage of revenue, and successful completion of a defined number of strategic initiatives in 2019 and 2020. These awards will vest 40% on the third anniversary of the grant date and 60% on the fourth anniversary of the grant date provided required service is completed through these dates.

During the year ended December 31, 2018, we awarded performance share awards that are subject to service and performance vesting conditions. The quantity of shares that will vest range from 0% to 300% of the targeted number of shares based on performance factors related to our growth in comparable restaurant sales and average restaurant margin over a three year period beginning on January 1, 2018. If the defined minimum targets are not met, then no shares will vest.

During the year ended December 31, 2017, we awarded performance shares that are subject to service, market and performance vesting conditions. Two-thirds of the shares 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 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.

No stock awards with market conditions were granted during the years ended December 31, 2019 and 2018. Measurement of the grant date fair value of stock awards with market conditions in 2017 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:

2017
Risk-free interest rate1.5%
Expected life (years)3.0
Expected dividend yield0.0%
Volatility29.9%

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.

10. Employee Benefit Plans

**Defined Contribution Plan—**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, 2019, 2018, and 2017, matching contributions totaled approximately $6,968, $6,090 and $6,072, respectively and are included in general and administrative expenses on the consolidated statements of income.

**Deferred Compensation Plan—**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, 2019 and 2018, were $12,811 and $10,872, respectively, and are included in other liabilities on the consolidated balance sheets. 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, 2019, 2018, and 2017, we made deferred compensation matches of $412, $152, and $199, respectively, to the Deferred Plan and are included in general and administrative expenses on the consolidated statements of income.

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, carried at fair value, and are included in other assets on the consolidated balance sheets. Fair value of mutual funds is measured using Level 1 inputs. The fair value of the investments in the rabbi trust was $12,811 and $10,872 as of December 31, 2019 and 2018, respectively. We record trading gains and losses in general and administrative expenses on the consolidated statements of income, along with the offsetting amount related to the increase or decrease in deferred compensation to reflect our exposure to liabilities for payment under the deferred plan.

**Employee Stock Purchase Plan—**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, 2019. For the years ended December 31, 2019, 2018, and 2017, the number of shares issued each year under the ESPP was less than one.

11. Leases

Related to the adoption of Topic 842, and for leases executed subsequent to the adoption of Topic 842 our policy elections are as follows:

Separation of lease and non-lease componentsWe elected this expedient to account for lease and non-lease components as a single component for our entire population of operating lease assets.
Short-term policyWe have elected the short-term lease recognition exemption for all applicable classes of underlying assets. Short-term disclosures include only those leases with a term greater than one month and 12 months or less, and expense is recognized on a straight-line basis over the lease term. Leases with an initial term of 12 months or less, that do not include an option to purchase the underlying asset that we are reasonably certain to exercise, are not recorded on the consolidated balance sheets.

Supplemental balance sheet information related to leases was as follows:

December 31,
Operating LeasesClassification2019
Right-of-use assetsOperating lease assets$2,505,466
Current lease liabilitiesCurrent operating lease liabilities173,139
Non-current lease liabilitiesLong-term operating lease liabilities2,678,374
Total lease liabilities$2,851,513
December 31,
2019
Weighted average remaining lease term (years)13.4
Weighted average discount rate5.19%

The components of lease cost were as follows:

Three months endedYear ended
December 31,December 31,
Classification20192019
Operating lease costOccupancy, General and administrative expenses and Pre-opening costs$79,597$308,586
Short-term lease costOther operating costs1,0273,238
Variable lease costOccupancy9,01936,828
Sublease incomeGeneral and administrative expenses(824)(3,385)
Total lease cost$88,819$345,267

Supplemental disclosures of cash flow information related to leases were as follows:

Three months endedYear ended
December 31,December 31,
20192019
Cash paid for operating lease liabilities$75,189$295,113
Operating lease assets obtained in exchange for operating lease liabilities(1)$83,079$2,702,778
Derecognition of operating lease assets due to terminations or impairment$3,755$17,740

(1) Amounts for the year ended December 31, 2019, include the transition adjustment for the adoption of Topic 842 discussed in Note 1. “Description of Business and Summary of Significant Accounting Policies.”

Maturities of lease liabilities were as follows as of December 31, 2019:

Operating Leases
2020$286,807
2021313,729
2022313,577
2023309,068
2024297,457
Thereafter2,483,595
Total lease payments4,004,233
Less: imputed interest1,152,720
Present value of lease liabilities$2,851,513

As of December 31, 2019, the total lease payments include $2,127,446 related to options to extend lease terms that are reasonably certain of being exercised, and exclude approximately $105,000 of legally binding minimum lease payments for leases signed but not yet commenced and $9,514 of future sublease income.

As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting, maturities of lease liabilities were as follows as of December 31, 2018:

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

As of December 31, 2018, maturities of lease liabilities have not been reduced by minimum sublease income of $11,790 due in the future under our subleases. As of December 31, 2018, we had $90,484 of legally binding minimum lease payments related to leases that have not yet commenced.

We have six sale and leaseback transactions, which do not qualify for sale leaseback accounting due to fixed price renewal options prohibiting sale accounting. These transactions are accounted for under the financing method. Under the financing method, the assets remain on the consolidated balance sheets 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 as of December 31, 2018, with the current portion of the liability included in accrued liabilities, and the remaining portion included in other liabilities on the consolidated balance sheets.

12. Earnings Per Share

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

Year ended December 31,
201920182017
Net income$350,158$176,553$176,253
Shares:
Weighted-average number of common shares outstanding (for basic calculation)27,74027,82328,491
Dilutive stock awards55513970
Weighted-average number of common shares outstanding (for diluted calculation)28,29527,96228,561
Basic earnings per share$12.62$6.35$6.19
Diluted earnings per share$12.38$6.31$6.17

The following stock awards were excluded from the calculation of diluted earnings per share:

Year ended December 31,
201920182017
Stock awards subject to performance conditions8195217
Stock awards that were antidilutive1391,7411,695
Total stock awards excluded from diluted earnings per share2201,8361,912

13. 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, we detected malware in our payment processing network that was designed to access payment card data from cards used at point-of-sale devices at most of our restaurants. We removed the malware from our systems and self-reported the issue to payment card processors and law enforcement, and we continue to enhance our security measures. Substantially all of our investigation costs related to this incident have been covered by insurance.

As a result of this incident, several lawsuits were filed alleging, among other things, that we negligently failed to provide adequate security to protect the payment card information of the plaintiffs and other similarly situated customers. These lawsuits were consolidated into one action captioned Todd Gordon, et. al. v. Chipotle Mexican Grill, Inc., which was pending in the United States District Court for the District of Colorado. In March 2019, we reached an agreement to settle the consolidated Gordon action, and in December 2019 the court granted final approval of the settlement. The financial terms of the Gordon settlement were covered by insurance.

As of December 31, 2019, we had a balance of $15,000 for loss contingencies related to the data security incident on the consolidated balance sheet, which is included in the accrued liabilities line item. We ultimately may be subject to liabilities greater or less than the amount accrued.

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. Since then we have received additional subpoenas requesting information related to illness incidents associated with several of our restaurants, and we may receive additional subpoenas in the future related to illness incidents at these or other restaurants. We have cooperated with the investigation, and we are in discussions with the U.S. Attorney's Office in an effort to resolve this matter through a settlement. We believe that if a settlement is reached, it will contain both monetary and non-monetary elements, including a deferred prosecution agreement and additional undertakings by the Company. We have reserved a total of $25 million in connection with this investigation, which we believe is a reasonable estimate of the amount we may be expected to pay to settle this matter. Based on discussions to date, we are hopeful that a settlement can be reached; however, there can be no assurance that a settlement will be reached or as to the ultimate timing or monetary or non-monetary terms of such a settlement.

Shareholder Class Action

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 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. We intend to continue vigorously defending the case, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from the case.

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.

Accrual for Estimated Liability

Excluding the accrual for the data security incident described above, we had a balance of $45,721 on the consolidated balance sheet as of December 31, 2019, which is included in the accrued liabilities line item. We ultimately may be subject to liabilities greater or less than the amount accrued.

**14. Quarterly Financial Data (**Unaudited)

The following table presents summarized unaudited quarterly financial data from the consolidated statements of income for each of the eight quarters in the periods ended December 31, 2019 and December 31, 2018. The operating results for any quarter are not necessarily indicative of the results for any subsequent quarter. Basic and diluted net income per share calculations for each quarter is based on the weighted average diluted shares outstanding for that quarter and may not sum to the full year total amount as presented on our consolidated statements of income:

2019
March 31June 30September 30December 31
Revenue$1,308,217$1,434,231$1,403,697$1,440,224
Income from operations$110,161$120,020$115,621$98,156
Net income$88,132$91,028$98,582$72,416
Basic earnings per share$3.18$3.28$3.55$2.61
Diluted earnings per share$3.13$3.22$3.47$2.55
2018
March 31June 30September 30December 31
Revenue$1,148,397$1,266,520$1,225,007$1,225,061
Income from operations$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

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