Notes to Condensed Consolidated Financial Statements
(unaudited)
(dollar and share amounts in thousands, unless otherwise specified)
1. Basis of Presentation
Chipotle Mexican Grill, Inc., a Delaware corporation, together with its subsidiaries (collectively the “Company”), develops and operates fast-casual, fresh Mexican food restaurants (“Chipotle restaurants”). As of
September 30
, 2016, the Company operated
2,
129
Chipotle restaurants throughout the United States. The Company also had
1
5
Chipotle restaurants in Canada,
s
ix
in England,
five
in France, and
one
in Germany. Further, the Company operated
15
ShopHouse Southeast Asian Kitchen restaurants
, or “ShopHouse
,
”
serving fast-casual, Asian inspired cuisine,
and
is an investor in a consolidated entity that owned and operated
seven
Pizzeria Locale restaurants, a fast-casual pizza concept. The Company
managed its operations based on 10
regions during the
third
quarter 2016 and has aggregated its operations to
one
reportable segment.
The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of its financial position and results of operations. Interim results of operations are not necessarily indicative of the results that may be achieved for the full year. The financial statements and related notes do not include all information and footnotes required by U.S. generally accepted accounting principles for annual reports. This quarterly report should be read in conjunction with the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2015.
2. Accounting Policies
Revenue Recognition
The Company recognizes revenue, net of discounts and incentives, when payment is tendered at the point of sale. The Company recognizes a liability for offers of free food
that do not require customers to make a purchase
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 in the consolidated statement of
income
and in accrued liabilities in the consolidated balance sheet. The Company reports revenue net of sales
-
related taxes collected from customers and remitted to governmental taxing authorities.
Du
ring the third quarter, the Company
introduced a limited-time frequency program called Chiptopia Summer Rewards. Customers earn
ed different rewards based on
their
number of monthly
visits from July 1, 2016
,
through September 30, 2016. For the three months ended Sep
tember 30, 2016, the Company deferred
$11,
457
of revenue
reflecting the portion of original sales allocated to the rewards that were earned by program participants and not redeemed as of September 30, 2016, and recorded a corresponding liability in accrued liabilities on its condensed consolidated balance s
heet. The
portion of revenue allocated to
the rewards is based on the estimated value of the
award
earned
and takes into consideration
company-specific
historical redemption patterns
for similar promotions
.
Re
wards expire according to the terms in the Chiptopia Summer Rewards terms and conditions. W
hen a customer redeems a
reward or when it expires,
the Company
will
recognize revenue for the redeemed product and reduce the related liability.
Recently Issued Accounting Standards
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” as ame
nded by multiple
updates. The pronouncement was issued to clarify the principles for recognizing revenue and to develop a common revenue standard and disclosure requirements for U.S. GAAP and IFRS. The pronouncement is effective for reporting periods beginning after December 15, 2017.
The expected adoption method
of ASU 2014-09
is being evaluated by the Company, and
the adoption is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The pronouncement requires the recognition of a liability for lease obligations and a corresponding right-of-use asset on the balance sheet and disclosure of key information about leasing arrangements. This pronouncement is effective for reporting periods beginning after December 15, 2018 using a modified retrospective adoption method. The Company’s adoption of ASU No. 2016-02 will have a significant impact on its consolidated balance sheet as it will record material assets and obligations for current operating leases. The Company is evaluating the impact that adoption will have on its consolidated statement of income.
In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718).” The pronouncement was issued to simplify the accounting for share-based payment transactions, including income tax consequences, the classification of awards as either equity
or liabilities, and the classification on the statement of cash flows. The pronouncement is effective for reporting periods beginning after December 15, 2016.
This guidance will be applied either prospectively, retrospectively or using a modified retrospective transition method, depending on the area covered in this update. Upon adoption, any future excess tax benefits or deficiencies will be recorded to the provision for income taxes in the consolidated statement of income, instead of additional paid-in capital in the consolidated balance sheets. For the nine months ended September 30, 2016, and for the year ended December 31, 2015,
$1,888
and
$74,442
, respectively, of excess tax benefits were recorded to additional paid-in capital that would have been recorded as a reduction to the provision for income taxes if this new guidance
could have
been adopted as of the respective dates. Additionally, excess tax benefits will be classified as operating activities in the consolidated statement of cash flow instead of in financing activities as required under the current guidance. The Company has not selected a transition method, and except as described above, does not expect the provisions of the ASU to have a significant impact on the Company’s consolidated financial position or results of operations.
Recently Adopted Accounting Standards
In June 2014, the FASB issued ASU No. 2014-12, “Compensation – Stock Compensation (Topic 718).” The pronouncement was issued to clarify the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The pronouncement was effective for reporting periods beginning after December 15, 2015, and the Company adopted the guidance prospectively. The adoption of ASU 2014-12 did not have a significant impact on the Company’s consolidated financial pos
ition or results of operations.
In April 2015, the FASB issued ASU No. 2015-05, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40).” The pronouncement was issued to provide guidance concerning accounting for fees in a cloud computing arrangement. The pronouncement was effective for reporting periods beginning after December 15, 2015, and the Company adopted the guidance prospectively. The adoption of ASU 2015-05 did not have a significant impact on the Company’s consolidated financial position or results of operations
.
3. Fair Value of Financial Instruments
The carrying
value of the Company’s cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of their short-term nature. Investments are carried at fair market value and are classified as available-for-sale. Investments consist of U.S. treasury notes with maturities up to approximately
18 months
. Fair value
of investments
is measured using Level 1 inputs (quoted prices for identical assets in active markets).
The following is a summary of available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
December 31,
|
|
2016
|
|
2015
|
Amortized cost
|
$
|
455,097
|
|
$
|
1,040,850
|
Gross unrealized gains (losses)
|
|
583
|
|
|
(2,712)
|
Fair market value
|
$
|
455,680
|
|
$
|
1,038,138
|
There were
no
realized
gain
s (losses) from sales of available-for-sale securities
during the three months ended
September 30, 2016 and 2015. Realized gains were
$547
and
$0
for the nine months ended September 30, 2016 and 2015, respectively
.
The Company records realized gains and losses from sales of available-for-sale securities in interest and other income (expense)
in the
consolidated statement of income.
The Company also maintains a rabbi trust to fund obligations under a deferred compensation plan. Amounts in the rabbi trust are invested in mutual funds, which are designated as trading securities and carried at fair value, and are included in other assets in the consolidated balance sheet. Fair market value of mutual funds is measured using Level 1 inputs. The fair value of the investments in the rabbi trust was $
17,515
and $
18,331
as of
September 30
, 2016 and December 31, 2015, respectively. The Company records trading gains and losses in general and administrative expenses in the
consolidated statement of income
, along with the offsetting amount related to the increase or decrease in deferred compensation to reflect its exposure to liabilities for p
ayment under the deferred plan.
The following table sets forth unrealized gains and losses on investments held in the rabbi trust:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Unrealized gains (losses) on investments held in rabbi trust
|
$
|
391
|
|
$
|
(1,000)
|
|
$
|
677
|
|
$
|
(744)
|
4. Impairment of Long-Lived Assets
During the three months ended September 30, 2016, the Company determined that its ShopHouse restaurants were impaired and recognized a non-cash impairment charge of
$14,505
($8,539 net of tax), representing substantially all of the value of the long-lived assets of ShopHouse, in loss on disposal and impairment of assets on the consolidated statement of income and comprehensive income ($0.29 on basic and dilutive earnings per share). The decision to impair the assets was based on an analysis of each restaurant’s past and present operating performance, including a significant change from comparable restaurant sales increases to decreases, and projected future cash flows expected to be generated by the restaurant assets. The fair value of ShopHouse restaurants was determined using level 3 inputs (unobservable inputs) based on a discounted cash flows method. The Company has decided not to invest further in developing and growing the ShopHouse brand and will pursue strategic alternatives.
5
. Shareholders’ Equity
Through
September 30, 2016, the Company had announced authorizations by its Board of Directors of repurchases of shares of common stock, which in the aggregate authorized expenditures of up to
$2,000,000
. On October 25, 2016, the Company announced that its Board of Directors authorized the expenditure of up to an additional
$100,000
to repurchase shares of common stock. Under the remaining repurchase authorization, shares may be purchased from time to time in open market transactions, subject to market conditions.
During the
nine
months ended
September 30,
201
6
, the Company repurchased
1,641
shares of common stock under authorized programs, for a total cost of $
747,237
. The cumulative shares repurchased under authorized programs as of
September 30
, 201
6,
were
6,693
for a total cost of $
1,931,164
. As of
September 30, 2016
, $
69,207
was available to rep
urchase shares under the announced
repurchase authorizations.
The shares are being held in treasury stock until such time as they are reissued or retired at the discretion of the Board of Directors.
6
. Stock-based Compensation
During the
nine
months ended
September 30
, 2016, the Company granted stock only stock appreciation rights (“SOSARs”) on
46
0
shares of its common stock to eligible employees. The weighted average grant date fair value of the SOSARs was $
117.48
per share with a wei
ghted average exercise price of
$
45
7.77
per share based on the closing price of common stock on the date of grant. The SOSARs vest in two equal installments on the
second
and
third
anniversary of the grant date. During the
nine
months ended
September 30,
2016,
118 SOSARs were exercised
and
77
SOSARs were forfeited.
During the first quarter of 2016, the Company awarded shares that are subject to
both service and
market
vesting
conditions. The quantity of shares that will vest may range from
0%
to
400%
of a targeted number of shares, and will be
determined based on the price of the Company’s 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.
The following table sets forth total stock based compensation expense:
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|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Stock based compensation expense
|
$
|
18,636
|
|
$
|
20,668
|
|
$
|
49,357
|
|
$
|
58,562
|
Stock based compensation expense (net of tax)
|
$
|
10,971
|
|
$
|
12,758
|
|
$
|
29,056
|
|
$
|
36,150
|
Stock based compensation expense recognized as capitalized development
|
$
|
285
|
|
$
|
329
|
|
$
|
968
|
|
$
|
1,163
|
During the first quarter of 2016, the Company adjusted its estimate of stock awards expected to vest based on performance conditions, which resulted in a cumulative reduction of expense of
$6,031
(
$
3,687
net of tax and
$0.12
to basic and diluted earnings (loss) per share).
7. Earnings
Per Share
Basic earnings
per share is calc
ulated 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”) i
s calculated using income
available to common shareholders divided by diluted weighted-average shares of common stock outstanding during each period. Potentially dilutive securities include common shares related to SOSARs and non-vested stock awards (collectively “stock awards”). Stock awards are excluded from the calculation of diluted EPS in the event they are subject to performance conditions or are antidilutive. Diluted EPS considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an antidilutive effect.
The following stock awards were excluded from the calcul
ation of diluted earnings
per share:
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|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Stock awards subject to performance conditions
|
|
226
|
|
|
216
|
|
|
276
|
|
|
282
|
Stock awards that were antidilutive
|
|
1,356
|
|
|
320
|
|
|
1,312
|
|
|
267
|
Total stock awards excluded from diluted earnings per share
|
|
1,582
|
|
|
536
|
|
|
1,588
|
|
|
549
|
The following table sets forth the computations of b
asic and diluted earnings
per share:
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Three months ended September 30,
|
|
Nine months ended September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Net income
|
$
|
7,799
|
|
$
|
144,883
|
|
$
|
6,963
|
|
$
|
407,728
|
Shares:
|
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|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding
|
|
29,063
|
|
|
31,187
|
|
|
29,387
|
|
|
31,115
|
Dilutive stock awards
|
|
108
|
|
|
361
|
|
|
405
|
|
|
441
|
Diluted weighted average number of common shares outstanding
|
|
29,171
|
|
|
31,548
|
|
|
29,792
|
|
|
31,556
|
Basic earnings per share
|
$
|
0.27
|
|
$
|
4.65
|
|
$
|
0.24
|
|
$
|
13.10
|
Diluted earnings per share
|
$
|
0.27
|
|
$
|
4.59
|
|
$
|
0.23
|
|
$
|
12.92
|
8
. Commitments and Contingencies
Receipt of Grand Jury Subpoenas
In
December 2015, the Company was 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 Company to produce a broad range of documents related to a Chipotle restaurant in Simi Valley, California, that experienced an isolated norovirus incident during August 2015. On January 28, 2016, the Company was served with an additional subpoena broadening the investigation and requiring the production of documents and information related to company-wide food safety matters dating back to January 1, 2013. The Company has been informed that this subpoena supersedes the subpoena served in December 2015, which has been withdrawn. The Company intends to
continue to
fully cooperate in the investigation. It is not possible at this time to determine whether the Company will incur, or to reasonably estimate the amount of, any fines or penalties in connection with the investigation pursuant to which the subpoena was issued.
Shareholder 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 the Company’s common stock between February 4, 2015 and January 5, 2016. The complaint purports to state claims against the Company, each of its co-Chief Executive Officers and its Chief Financial Officer under Sections 10(b) and 20(a) of the Exchange Act and related rules, based on the Company’s alleged failure during the claimed class period to disclose material information about the Company’s quality controls and safeguards in relation to consumer and employee health. The complaint asserts that those
alleged
failures and related public statements were false and misleading and that, as a result, the market price of the Company’s 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. The Company intends to defend this case vigorously, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from the case.
Shareholder Derivative Actions
On March 21, 2016, Jessica Oldfather filed a shareholder derivative action in the Court of Chancery of the State of Delaware alleging that the Company’s Board of Directors and officers breached their fiduciary duties in connection with allegedly excessive compensation awarded from 2011 to 2015 under the Company’s stock incentive plan. On April 6, 2016, Uri Skorski filed a shareholder derivative action in Colorado state court in Denver, Colorado, making largely the same allegations as the Oldfather complaint and also alleging that the Company’s Board of Directors and officers breached their fiduciary duties in connection with the Company’s alleged failure to disclose material information about the Company’s food safety policies and procedures. On April 1
4
, 2016, Mark Arnold and Zachary Arata filed a shareholder derivative action in
Colorado state court in Denver, Colorado, making largely the same allegations as the Skorski complaint.
On August 8, 2016, Sean Gubricky filed a shareholder derivative action the U.S. District Court for the District of Colorado, alleging that the Company’s Board of Directors and certain officers failed to institute proper food safety controls and policies, issued materially false and misleading statements in violation of federal securities laws, and otherwise breached their fiduciary duties to the Company. On September 1, 2016, Ross Weintraub filed a shareholder derivative action in Colorado state court in Denver, Colorado, making largely the same allegations as the Gubricky complaint.
Each of these actions purports to state a claim for damages on behalf of the Company, and is based on statements in the Company’s SEC filings and related public disclosures, as well as media reports and Company records. The Company intends to defend these cases vigorously, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from these cases.
Notices of Inspection of Work Authorization Documents and Related Civil and Criminal Investigations
Following an inspection during 2010 by the U.S. Department of Homeland Security, or DHS, of the work authorization documents of the Company’s restaurant employees in Minnesota, the Immigration and Customs Enforcement arm of DHS, or ICE, issued to the Company a Notice of Suspect Documents identifying a large number of employees who, according to ICE and notwithstanding the Company’s review of work authorization documents for each employee at the time they were hired, appeared not to be authorized to work in the U.S. The Company approached each of the named employees to explain ICE’s determination and afforded each employee an opportunity to confirm the validity of their original work eligibility documents, or provide valid work eligibility documents. Employees who were unable to provide valid work eligibility documents were terminated in accordance with the law. In December 2010, the Company was also requested by DHS to provide the work authorization documents of restaurant employees in the District of Columbia and Virginia, and the Company provided the requested documents in January 2011. The Company subsequently received requests
from the office of the U.S. Attorney for the District of Columbia
for work authorization documents covering all of the Company’s employees since 2007, plus employee lists and other documents concerning work authorization. The Company believes its practices with regard to the work authorization of its employees, including the review and retention of work authorization documents, are in compliance with applicable law. However, the termination of large numbers of employees in a short period of time does disrupt restaurant operations and results in a temporary increase in labor costs as new employees are trained.
In May 2012, the U.S. Securities and Exchange Commission notified the Company that it is conducting a civil investigation of the Company’s compliance with employee work authorization verification requirements and its related discl
osures and statements, and the o
ffice of the U.S. Attorney for the District of Columbia advised the Company that its investigation has broadened to include a parallel criminal and civil investigation of the Company’s compliance with federal securities laws. The Company intends to continue to fully cooperate in the government’s investigations. It is not possible at this time to determine whether the Company will incur, or to reasonably estimate the amount of, any fines, penalties or further liabilities in connection with these matters.
Miscellaneous
The Company is involved in various other claims and legal actions that arise in the ordinary course of business. The Company does not believe that the ultimate resolution of these actions will have a material adverse effect on the Company’s 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 the Company incurs greater liabilities than the Company currently anticipates, could materially and adversely affect the Company’s business, financial condition, results of operations and cash flows.