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LEASES

6 Months Ended

Jun. 26, 2019

Effect of Standard Adoption

On December 27, 2018 we adopted ASU 2016-02, Leases (Topic 842), using a modified retrospective approach. We elected the package of practical expedients permitted under the transition guidance within Accounting Standards Codification Topic 842 ("ASC 842") which, among other items, allowed us to carry forward the historical lease classifications. As such, we applied the modified retrospective approach as of the adoption date to those lease contracts for which we have taken possession of the property as of December 26, 2018. As part of the transition, we derecognized all landlord funded assets and deemed landlord financing liabilities as of December 26, 2018 and determined the classification as either operating or finance leases.

In addition to the aforementioned practical expedient, we have also elected to:


▪	Adopt the short-term lease exception for leases with terms of twelve months or less and account for them as if they were operating leases under ASC 840; and


▪	Apply the practical expedient of combining lease and non-lease components.

Results for reporting periods beginning on or after December 27, 2018 are presented under ASC 842. Prior period amounts were not revised and continue to be reported in accordance with ASC Topic 840 ("ASC 840"), the accounting standard then in effect.

Upon transition, on December 27, 2018, we recorded the following increases (decreases) to the respective line items on the Condensed Consolidated Balance Sheet:



	Adjustment as of December 27, 2018
Prepaid expenses and other current assets	$	6
Property and equipment, net	(11,448		)
Operating lease assets	229,885
Deferred income taxes, net	(121		)
Deemed landlord financing	(20,846		)
Deferred rent	(47,862		)
Long-term operating lease liabilities	277,224
Other long-term liabilities	4,611
Retained earnings	4,136
Non-controlling interests	1,059

Nature of Leases

We lease all of our domestic company-operated Shacks, our Home Office and certain equipment under various non-cancelable lease agreements that expire on various dates through 2035. We evaluate contracts entered into to determine whether the contract involves the use of property or equipment, which is either explicitly or implicitly identified in the contract. We evaluate whether we control the use of the asset, which is determined by assessing whether we obtain substantially all economic benefits from the use of the asset, and whether we have the right to direct the use of the asset. If these criteria are met and we have identified a lease, we account for the contract under the requirements of ASC 842.

Upon the possession of a leased asset, we determine its classification as an operating or finance lease. Most of our real estate leases are classified as operating leases and most of our equipment leases are classified as finance leases. Generally, our real estate leases have initial terms ranging from 10 to 15 years and typically include two five-year renewal options. Renewal options are generally not recognized as part of the right-of-use assets and lease liabilities as it is not reasonably certain at commencement date that we would exercise the options to extend the lease. Our real estate leases typically provide for fixed minimum rent payments and/or contingent rent payments based upon sales in excess of specified thresholds. When the achievement of such sales thresholds are deemed to be probable, contingent rent is accrued in proportion to the sales recognized during the period. For operating leases that include rent holidays and rent escalation clauses, we recognize lease expense on a straight-line basis over the lease term from the date we take possession of the leased property. Lease expense incurred before a Shack opens is recorded in pre-opening costs. Once a domestic company-operated Shack opens, we record the straight-line lease expense and any contingent rent, if applicable, in occupancy and related expenses on the Consolidated Statements of Income. Many of our leases also require us to pay real estate taxes, common area maintenance costs and other occupancy costs which are included in occupancy and related expenses on the Consolidated Statements of Income.

As there were no explicit rates provided in our leases, we used our incremental borrowing rate in determining the present value of future lease payments. The discount rate used to measure the lease liability at the transition date was derived from the average of the yield curves obtained from using the notching method and the recovery rate method. The most significant assumption in calculating the incremental borrowing rate is our credit rating and subject to judgment. We determined our credit rating based on a comparison of the financial information of SSE Holdings to 800 other public companies and then used their respective credit ratings to develop our own.

We expend cash for leasehold improvements to build out and equip our leased premises. Generally, a portion of the leasehold improvements and building costs are reimbursed by our landlords as landlord incentives pursuant to agreed-upon terms in our lease

agreements. If obtained, landlord incentives usually take the form of cash, full or partial credits against our future minimum or contingent rents otherwise payable by us, or a combination thereof. In most cases, landlord incentives are received after we take possession of the property, as we meet required milestones during the construction of the property. We include these amounts in the measurement of the initial operating lease liability, which are also reflected as a reduction to the initial measurement of the right-of-use asset.

A summary of finance and operating lease right-of-use assets and liabilities as of June 26, 2019 is as follows:



	Classification	June 26 2019
Finance leases	Property and equipment, net	$	4,968
Operating leases	Operating lease assets	257,969
Total right-of-use assets		$	262,937

Finance leases:
	Other current liabilities	1,830
	Other long-term liabilities	3,179
Operating leases:
	Operating lease liabilities, current	24,139
	Long-term operating lease liabilities	292,643
Total lease liabilities		$	321,791

The components of lease expense for the thirteen and twenty-six weeks ended June 26, 2019 were as follows:



			Thirteen Weeks Ended		Twenty-Six Weeks Ended
		Classification	June 26 2019		June 26 2019
Finance lease cost:
	Amortization of right-of-use assets	Depreciation expense	$	619	$	953
	Interest on lease liabilities	Interest expense	55		96
Operating lease cost		Occupancy and related expenses General and administrative expenses Pre-opening costs	9,855		18,765
Short-term lease cost		Occupancy and related expenses	17		34
Variable lease cost		Occupancy and related expenses General and administrative expenses Pre-opening costs	3,836		7,298
Total lease cost			$	14,382	$	27,146

As of June 26, 2019, future minimum lease payments for finance and operating leases consisted of the following:



	Finance Leases		Operating Leases
2019	$	1,047	$	21,127
2020	1,656		43,747
2021	1,060		44,456
2022	670		45,169
2023	518		45,068
Thereafter	475		240,724
Total minimum payments	5,426		440,291
Less: imputed interest	417		123,509
Total lease liabilities	$	5,009	$	316,782

As of June 26, 2019 we had additional operating lease commitments of $67,362 for non-cancelable leases without a possession date, which will begin to commence in 2019. These lease commitments are consistent with the leases that we have executed thus far and include a number of real estates leases where we are involved in the construction and design.

A summary of lease terms and discount rates for finance and operating leases as of June 26, 2019 is as follows:



		June 26 2019
Weighted-average remaining lease term (years):
	Finance leases	5.2
	Operating leases	10.0
Weighted-average discount rate:
	Finance leases	3.9	%
	Operating leases	4.7	%

Supplemental cash flow information related to leases as of June 26, 2019 is as follows:



		June 26 2019
Cash paid for amounts included in the measurement of lease liabilities:
	Operating cash flows from finance leases	$	96
	Operating cash flows from operating leases	17,342
	Financing cash flows from finance leases	912
Right-of-use assets obtained in exchange for lease obligations:
	Finance leases	1,311
	Operating leases	38,437

LEASES