CHIPOTLE MEXICAN GRILL INC

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 balance sheet. The guidance requires disclosure of key information about leasing arrangements that is intended to give financial statement users the ability to assess the amount, timing, and potential uncertainty of cash flows related to leases. We 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 condensed financial statements.

In May 2018, we announced that we would open a headquarters office in Newport Beach, California, consolidate certain corporate administrative functions into our existing office in Columbus, Ohio, and close our existing headquarters offices in Denver, Colorado, as well as additional corporate offices in New York, New York. All affected employees were either offered an opportunity to continue in the new organization or were offered a severance package. We record severance as a one-time termination benefit and recognize the expense ratably over the employees’ required future service period. We evaluate our operating lease assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the operating lease asset (or asset group that includes the operating lease asset, referred to interchangeably throughout as an operating lease asset) may not be recoverable. We first compare the carrying value of the operating lease asset to the operating lease asset’s estimated future undiscounted cash flows. If the estimated undiscounted future cash flows are less than the carrying value of the operating lease asset, we determine if we have an impairment loss by comparing the carrying value of the operating lease asset to the operating lease asset's estimated fair value. The estimated fair value of the operating lease asset is generally determined using a discounted cash flow projection model, using Level 3 inputs. The impairment charges represent the excess of each operating lease asset’s carrying amount over its estimated fair value. All other costs, including other employee transition costs, recruitment and relocation costs, other office closure costs, and third-party costs, are recognized in the period incurred.

Operating lease assets and liabilities are recognized at the lease commencement date. 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 secured borrowing rates corresponding to the maturities of the leases. 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.

During the three months ended March 31, 2019, we reached agreements to settle the consolidated action captioned Bellwether Community Credit Union, et. al. v. Chipotle Mexican Grill, Inc., as well as the consolidated action captioned Todd Gordon, et. al. v. Chipotle Mexican Grill, Inc., each of which was pending in the United States District Court for the District of Colorado.  Settlement of the Bellwether matter has been finalized and a stipulation of dismissal was filed with the court on March 28, 2019.  Court approval of the Gordon settlement is pending.  We do not expect that the settlements will exceed applicable insurance coverages or will have a material financial impact on us, although the total liabilities arising from the Gordon settlement will be dependent in part on the number of claims filed, and may exceed our expectations and applicable insurance coverage.

The effective income tax rate for income taxes as a percentage of income before income taxes was 22.2% and 36.9% for the three months ended March 31, 2019 and 2018, respectively. The decrease in the effective income tax rate for the three months ended March 31, 2019, when compared to 2018, was primarily due to unfavorable discrete tax items in the first quarter of 2018 including equity vesting at an amount less than original book value and negative impacts from tax reform, and favorable discrete tax items in the first quarter of 2019 related to stock option exercises.