Notes to Condensed Consolidated Financial Statements
(unaudited)
(dollar and share amounts in thousands, unless otherwise specified)
1. Basis of Presentation
In this quarterly report on Form 10-Q, Chipotle Mexican Grill, Inc., a Delaware corporation, together with its subsidiaries, is collectively referred to as “Chipotle,” “we,” “us,” or “our.”
We develop and operate restaurants that serve a focused menu of burritos, tacos, burrito bowls, and salads, made using fresh, high-quality ingredients. As of September 30, 2017, we operated 2,330 Chipotle restaurants throughout the United States as well as 36 international Chipotle restaurants and 8 non-Chipotle restaurants. We managed our operations based on 11 regions during the third quarter of 2017 and have aggregated our operations to one reportable segment.
We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of our financial position and results of operations. Interim results of operations are not necessarily indicative of the results that may be achieved for the full year. The financial statements and related notes do not include all information and footnotes required by U.S. generally accepted accounting principles for annual reports. This quarterly report should be read in conjunction with the consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2016.
2. Recent Accounting Standards
Recently Issued Accounting Standards
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842).” The pronouncement requires lessees to recognize a liability for lease obligations, which represent the discounted obligation to make future minimum lease payments, and a corresponding right-of-use asset on the balance sheet. The guidance requires disclosure of key information about leasing arrangements which are intended to give financial statement users the ability to assess the amount, timing, and potential uncertainty of cash flows related to leases. We expect to adopt the requirements of the new lease standard effective January 1, 2019, using a modified retrospective adoption method.
We are currently evaluating the provisions of the new lease standard, including optional practical expedients, and assessing our existing lease portfolio in order to determine the impact to our accounting systems,
processes and internal control
over financial reporting.
The adoption of ASU 2016-02 will have a significant impact on our consolidated balance sheet because we will record material assets and obligations for current operating leases. We are still assessing the expected impact on our consolidated statements of income and cash flows.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” as amended by multiple standards updates. This guidance requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, this guidance will require us to enhance our disclosures, including disclosing performance obligations to customers arising from gift cards and certain promotional activity. The pronouncement is effective for reporting periods beginning after December 15, 2017. The adoption is not expected to have an impact on our consolidated financial position or results of operations.
We reviewed all other recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact on the consolidated financial statements.
Recently Adopted Accounting Standards
In March 2016, the FASB issued ASU 2016-09, “Compensation-Stock Compensation (Topic 718).” The pronouncement was issued to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the condensed consolidated statement of cash flows.
We adopted ASU 2016-09 on January 1, 2017, prospectively (prior periods have not been restated). The primary impact of adoption was the recognition during the three months ended September 30, 2017, of a $77 tax deficiency, which increases our provision for income taxes and for the nine months ended September 30, 2017, an excess tax benefit of $587
,
which reduces our provision for income taxes and the classification of these excess tax benefits in operating activities in the condensed consolidated statement of cash flows instead of financing activities.
The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented in the condensed consolidated statement of cash flows, since such cash flows have historically been presented in financing activities. We also elected to continue estimating forfeitures when determining the amount of stock-based compensation costs to be recognized in each period. No other provisions of ASU 2016-09 had a material impact on our financial statements or disclosures.
3. Fair Value of Financial Instruments
The carrying
value of our cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of their short-term nature. Investments are carried at fair value and are classified as available-for-sale. Investments consist of U.S. treasury notes with maturities up to approximately one year. Fair value of investments is measured using Level 1 inputs (quoted prices for identical assets in active markets).
The following is a summary of available-for-sale securities:
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September 30,
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December 31,
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2017
|
|
2016
|
Amortized cost
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$
|
435,193
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|
$
|
455,109
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Unrealized gains (losses)
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|
(316)
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|
(218)
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Fair market value
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$
|
434,877
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$
|
454,891
|
The following is a summary of unrealized gains (losses) on available-for-sale securities recorded in other comprehensive income (loss) in the condensed consolidated statement of comprehensive income:
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Three months ended September 30,
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Nine months ended September 30,
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2017
|
|
2016
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|
2017
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|
2016
|
Unrealized gains (losses) on available-for-sale securities
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$
|
272
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|
$
|
(882)
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$
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(99)
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$
|
3,051
|
Unrealized gains (losses) on available-for-sale securities, net of tax
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$
|
168
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|
$
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(536)
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$
|
(72)
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$
|
1,866
|
Realized gains and losses on available-for-sale securities are recorded in interest and other income, net on the condensed consolidated statement of income. We had no realized gains or losses for the three and nine months ended September 30, 2017, and we had $0 and $547 of realized gains on available-for-sale securities for the three and nine months ended September 30, 2016.
We also maintain a rabbi trust to fund obligations under a deferred compensation plan. Amounts in the rabbi trust are invested in mutual funds, which are designated as trading securities and carried at fair value, and are included in other assets in the condensed consolidated balance sheet. Fair value of mutual funds is measured using Level 1 inputs. The fair value of the investments in the rabbi trust was $19,157 and $17,843 as of September 30, 2017, and December 31, 2016, respectively. We record trading gains and losses in general and administrative expenses in the condensed consolidated statement of income, along with the offsetting amount related to the increase or decrease in deferred compensation to reflect our exposure to liabilities for payment under the deferred plan.
The following table sets forth unrealized gains (losses) on trading securities held in the rabbi trust:
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Three months ended September 30,
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Nine months ended September 30,
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2017
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2016
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2017
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2016
|
Unrealized gains (losses) on trading securities held in rabbi trust
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$
|
335
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$
|
391
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$
|
1,157
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$
|
677
|
4. Impairment of Long-Lived Assets
During the three and nine months ended September 30, 2017, we recognized non-cash impairment charges of $2,
427
and $4,
441
(
$1,4
75
and
$2,6
99
net of tax, respectively), representing substantially all of the value of the long-lived assets
of a small number of
underperforming Chipotle restaurants, in loss on disposal and impairment of assets on the condensed consolidated statement of income ($0.05 and $0.09 per basic and diluted earnings per share). The fair value of the impaired restaurants was determined using Level 3 inputs (unobservable inputs)
based on a discounted cash flow
method.
5. Shareholders’ Equity
Through September 30, 2017, we had announced authorizations by our Board of Directors of repurchases of shares of common stock, which in the aggregate authorized expenditures of up to $2.3 billion. On October 24, 2017, we announced that our Board of Directors authorized the expenditure of an additional $100,000 to repurchase shares of common stock. Under the remaining repurchase authorizations, shares may be purchased from time to time in open market transactions, subject to market conditions.
During the nine months ended September 30, 2017, we repurchased 545 shares of common stock under authorized programs, for a total cost of $207,159. The cumulative shares repurchased under authorized programs as of September 30, 2017, were 7,408 for a total cost of $2,204,968. As of September 30, 2017, $95,425 was available to repurchase shares under the announced repurchase authorizations.
Shares repurchased are being held in treasury stock until such time as they are reissued or retired at the discretion of the Board of Directors.
6. Stock-based Compensation
During the nine months ended September 30, 2017, we granted stock only stock appreciation rights (“SOSARs”) on 304 shares of our common stock to eligible employees. The weighted average grant date fair value of the SOSARs was $105.97 per share with a weighted average exercise price of $426.70 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, 2017, 32 SOSARs were exercised and 124 SOSARs were forfeited.
During the nine months ended September 30, 2017, we granted restricted stock units (“RSUs”) on 89 shares of our common stock to eligible employees. The weighted average grant date fair value of the RSUs was $427.30 per share. The RSUs generally vest in two equal installments on the second and third anniversary of the grant date.
During the first quarter of 2017, we awarded 36 performance shares (“PSUs”) that are subject to service, market and performance vesting conditions. Two-thirds of the PSUs had a grant date fair value of $485.53 per share and vest based on the price of our common stock reaching certain targets for a consecutive number of days during the three-year period starting on the grant date and the quantity of shares that will vest range from 0% to 350% of the targeted number of shares. The remaining one-third of PSUs had a grant date fair value of $427.61 and vest based on reaching certain comparable restaurant sales increases during the three-year period starting on January 1, 2017, and the quantity of shares that will vest range from 0% to 300% of the targeted number of shares. If the defined minimum targets are not met, then no shares will vest.
During the nine months ended September 30, 2017, 20 stock awards that were subject to service and performance or market conditions were forfeited.
The following table sets forth total stock based compensation expense:
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Three months ended September 30,
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Nine months ended September 30,
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2017
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2016
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2017
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2016
|
Stock based compensation expense
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$
|
18,069
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$
|
18,636
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$
|
55,545
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$
|
49,357
|
Stock based compensation expense, net of tax
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$
|
10,983
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$
|
10,971
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$
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33,760
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$
|
29,056
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Stock based compensation expense recognized as capitalized development
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$
|
319
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$
|
285
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$
|
949
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$
|
968
|
Excess tax benefit (deficiency) on stock based compensation recognized in provision for income taxes
|
$
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(77)
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$
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-
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$
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587
|
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$
|
-
|
7. 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 common shares related to SOSARs and non-vested stock awards (collectively “stock awards”). Diluted EPS considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an antidilutive effect. Stock awards are excluded from the calculation of diluted EPS in the event they are subject to performance conditions or are antidilutive.
The following stock awards were excluded from the calculation of diluted earnings per share:
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Three months ended September 30,
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Nine months ended September 30,
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2017
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2016
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2017
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2016
|
Stock awards subject to performance conditions
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245
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226
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244
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276
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Stock awards that were antidilutive
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1,738
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1,356
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1,567
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1,312
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Total stock awards excluded from diluted earnings per share
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1,983
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1,582
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1,811
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1,588
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The following table sets forth the computations of basic and diluted earnings per share:
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Three months ended September 30,
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Nine months ended September 30,
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2017
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2016
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2017
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2016
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Net income
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$
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19,610
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$
|
7,799
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$
|
132,460
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$
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6,963
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Shares:
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Weighted average number of common shares outstanding
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28,415
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29,063
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28,604
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29,387
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Dilutive stock awards
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24
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|
108
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|
92
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|
|
405
|
Diluted weighted average number of common shares outstanding
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28,439
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29,171
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28,696
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29,792
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Basic earnings per share
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$
|
0.69
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$
|
0.27
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$
|
4.63
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$
|
0.24
|
Diluted earnings per share
|
$
|
0.69
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$
|
0.27
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$
|
4.62
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$
|
0.23
|
8. Commitments and Contingencies
Data Security Incident
In April 2017, our information security team detected unauthorized activity on the network that supports payment processing for our restaurants, and immediately began an investigation with the help of leading computer security firms. We also self-reported the issue to payment card processors and law enforcement. Our investigation
detected malware designed to access payment card data from cards used at point-of-sale devices at most Chipotle restaurants, primarily in the period from March 24, 2017 through April 18, 2017. The malware searched for track data, which may include cardholder name, card number, expiration date, and internal verification codes; however, no other customer information was affected. We have removed the malware from our systems and continue to evaluate ways to enhance our security measures.
We expect that substantially all of our investigation costs will be covered by insurance; however, we may incur legal expenses in excess of our insurance coverage limits associated with the data security incident in future periods. We will recognize these expenses as services are received.
During the three months ended September 30, 2017, we recorded an expense of $30,000 ($18,234 after tax), or $0.64 per
basic and
diluted earnings per share, as an estimate of p
otential
liabilities associated with anticipated claims and assessments by payment card networks in connection with the data security incident. We may ultimately be subject to liabilities greater
than
or less than the amount accrued. The expense is recorded in general and administrative expenses in our condensed consolidated statement of income and a corresponding liability in accrued liabilities on our condensed consolidated balance sheet.
Litigation Arising from Security Incident
On May 4, 2017, Bellwether Community Credit Union filed a purported class action complaint in the United States District Court for the District of Colorado alleging that we negligently failed to provide adequate security to protect the payment card information of customers of the plaintiffs and those of other similarly situated credit unions, banks and other financial institutions alleged to be part of the putative class, causing those institutions to suffer financial losses. The complaint also claims we were negligent per se based on alleged violations of Section 5 of the Federal Trade Commission Act and similar state laws. The plaintiff seeks monetary damages, injunctive relief and attorneys’ fees. On May 26, 2017, Alcoa Community Credit Union filed a purported class action complaint in the U. S. District Court for the District of Colorado making substantially the same allegations as the Bellwether complaint and seeking substantially the same relief. The Bellwether and Alcoa cases have been consolidated and will proceed as a single action.
On June 9, 2017, Todd Gordon filed a purported class action complaint in the U. S. District Court for the District of Colorado alleging that we negligently failed to provide adequate security to protect the payment card information of the plaintiff and other similarly situated customers alleged to be part of the putative class, causing such customers to suffer financial losses. The complaint also claims we were negligent per se
based on alleged violations of Section 5 of the Federal Trade Commission Act and similar state laws, and also alleges breach of contract, unjust enrichment, and violations of the Arizona Consumer Fraud Act. Additionally, on August 21, 2017, Greg Lawson and Judy Conard filed a purported class action complaint in the U. S. District Court for the District of Colorado making allegations substantially similar to those in the Gordon complaint, and stating substantially similar claims as well as claims under the Colorado Consumer Protection Act.
The plaintiffs in the Gordon case and the Lawson and Conard case have notified the court of their agreement to consolidate their cases and file an amended consolidated complaint for the consolidated matter.
We intend to vigorously defend each of the aforementioned cases,
but it is not possible at this time to reasonably estimate the outcome of or any potential liability from these cases.
Although certain fees and costs associated with the data security incident and the aforementioned litigation to date have been paid or reimbursed by our cyber liability insurer, the ultimate amount of liabilities arising from the litigation may be in excess of the limits of our applicable insurance coverage.
Receipt of Grand Jury Subpoenas
On January 28, 2016
, we were served with a Federal Grand Jury Subpoena from the U.S. District Court for the Central District of California in connection with an official criminal investigation being conducted by the U.S. Attorney’s Office for the Central District of California, in conjunction with the U.S. Food and Drug Administration’s Office of Criminal Investigations. The subpoena requires the production of documents and information related to company-wide food safety matters dating back to January 1, 2013.
We received a follow-up subpoena on July 19, 2017 requesting information related to illness incidents associated with a single Chipotle restaurant in Sterling, Virginia.
We intend to continue to fully cooperate in the investigation. It is not possible at this time to determine whether we will incur, or to reasonably estimate the amount of, any fines or penalties in connection with the investigation pursuant to which the subpoena was issued.
Shareholder Derivative Actions
On April 6, 2016, Uri Skorski filed a shareholder derivative action in Colorado state court in Denver, Colorado, alleging that our Board of Directors and officers breached their fiduciary duties in connection with our alleged failure to disclose material information about our food safety policies and procedures, and also alleging that our Board of Directors and officers breached their fiduciary duties in connection with allegedly excessive compensation awarded from 2011 to 2015 under our stock incentive plan. On April 14, 2016, Mark Arnold and Zachary Arata filed a shareholder derivative action in Colorado state court in Denver, Colorado, making largely the same allegations as the Skorski complaint.
On May 26, 2016, the court issued an order consolidating the Skorski and Arnold/Arata actions into a single case. On August 8, 2016, Sean Gubricky filed a shareholder derivative action in the U.S. District Court for the District of Colorado, alleging that our Board of Directors and certain officers failed to institute proper food safety controls and policies, issued materially false and misleading statements in violation of federal securities laws, and otherwise breached their fiduciary duties to us. On September 1, 2016, Ross Weintraub filed a shareholder derivative action in Colorado state court in Denver, Colorado, making largely the same allegations as the Gubricky complaint.
On March 27, 2017, the Weintraub case was consolidated with the Skorski and Arnold/Arata action into a single case.
On December 27, 2016, Cyrus Lashkari filed a shareholder derivative action in the U.S. District Court for the District of Colorado, making largely the same allegations as the foregoing shareholder derivative complaints. Each of these actions purports to state a claim for damages on our behalf, and is based on statements in our SEC filings and related public disclosures, as well as media reports and company records. We have reached an agreement to settle the foregoing actions, and the proposed settlement has been
preliminarily approved by
the U.S. District Court for the District of Colorado
.
On July 28, 2017, Mark Blau filed a shareholder derivative action in the U.S. District Court for the District of Colorado, making allegations similar to those of the several shareholder derivative actions described above, and adding further allegations related to the Board’s investigation of the foregoing matters, as well as customer illnesses and operational issues associated with two Chipotle restaurants in July 2017. The action purports to state claims for damages on our behalf, and is based on statements in our SEC filings and related public disclosures, as well as media reports and company records. We intend to defend 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 Class Actions
On
January 8, 2016, Susie Ong filed a complaint in the U.S. District Court for the Southern District of New York on behalf of a purported class of purchasers of shares of our common stock between February 4, 2015 and January 5, 2016. The complaint purports to state claims against us, each of the co-Chief Executive Officers serving during the claimed class period and the Chief Financial Officer under Sections 10(b) and 20(a) of the Exchange Act and related rules, based on our alleged failure during the claimed class period to disclose material information about our quality controls and safeguards in relation to consumer and employee health. The complaint asserts that those failures and related public statements were false and misleading and that, as a result, the market price of our stock was artificially inflated during the claimed class period. The complaint seeks damages on behalf of the purported class in an unspecified amount, interest, and an award of reasonable attorneys’ fees, expert fees and other costs. On March 8, 2017, the court granted our motion to dismiss the complaint, with leave to amend. The plaintiff filed an amended complaint on April 7, 2017.
Additionally, on
July 20, 2017, Elizabeth Kelly filed a complaint in the U.S. District Court for the District of Colorado on behalf of a purported class of purchasers of shares of our common stock between February 5, 2016 and July 19, 2017,
with claims and factual allegations similar to the Ong complaint, based primarily on media reports regarding illnesses associated with a Chipotle restaurant in Sterling, Virginia. We intend to defend these cases vigorously, but it is not possible at this time to reasonably estimate the outcome of or any potential liability from the cases.
Miscellaneous
We are involved in various other claims and legal actions that arise in the ordinary course of business. We do not believe that the ultimate resolution of these actions will have a material adverse effect on our financial position, results of operations, liquidity or capital resources. However, a significant increase in the number of these claims, or one or more successful claims under which we incur greater liabilities than we currently anticipate, could materially and adversely affect our business, financial condition, results of operations and cash flows.