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LEASES

3 Months Ended

Sep. 25, 2019

As of September 25, 2019, 1,075 of our 1,118 company-owned restaurant facilities were leased. We typically lease our restaurant facilities through ground leases (where we lease land only, but own the building) or retail leases (where we lease the land/retail space and building). Our leased restaurants are leased for an initial lease term which is typically 10 to 20 years, with one or more renewal terms typically ranging from 1 to 10 years. The leases typically provide for a fixed rental or a fixed rental plus percentage rentals based on sales volume. In addition to our restaurant facilities, we also lease our corporate headquarters location and certain technology and other restaurant equipment. Our lease agreements do not contain any material residual value guarantees or material covenant restrictions.

Adoption of ASC 842

Transition and Practical Expedient Elections

We adopted FASB Accounting Standards Codification (“ASC”) Topic 842, Leases (“ASC 842”), from the previous guidance ASC Topic ASC 840, Leases (“Legacy GAAP”) effective June 27, 2019, the first day of fiscal 2020. We adopted ASC 842 using the alternative transition method, such that our fiscal 2020 Consolidated Financial Statements (Unaudited) reflect ASC 842, while our prior period Consolidated Financial Statements (Unaudited) were prepared under Legacy GAAP and have not been restated. In connection with the adoption of ASC 842, we also elected the following practical expedients and policies:


•	Package of practical expedients - the election of this package allowed us to carry forward our historical lease classification, our assessment of whether a contract is or contains a lease, for any leases that existed prior to adoption of ASC 842.


•	Combine lease and non-lease components policy - we elected for all classes of underlying leased assets to account for lease and non-lease components (such as common area maintenance) and include executory costs (such as property taxes and insurance) to combine as a single lease component.

•

Short-term lease policy - we elected the short-term lease exemption from balance sheet recognition for all classes of underlying assets with an initial term of 12 months or less and that do not include an option to purchase the underlying asset that we are reasonably certain to exercise. Short-term leases are expensed as incurred in Restaurant expenses in the Consolidated Statements of Comprehensive Income (Unaudited)

We did not elect the hindsight practical expedient that permitted a reassessment of lease terms for existing leases.

Lease Accounting Policy under ASC 842

ASC 842 requires lessees to recognize on the balance sheet at lease commencement the lease assets and related lease liabilities for the rights and obligations created by operating and finance leases with lease terms of more than 12 months. The lease term commences on the date the lessor makes the underlying property available, irrespective of when lease payments begin under the contract. When determining the lease term at commencement, we consider both termination and renewal option periods available, and only include the period for which failure to renew the lease imposes a penalty on us in such an amount that renewal, or termination options, appear to be reasonably certain.

Upon adoption, our lease liability will generally be based on the present value of the lease payments, consisting of fixed costs and certain rent escalations, using our incremental borrowing rate applicable to the lease term. The right-of-use lease asset will generally be based on the lease liability, adjusted for amounts related to other lease-related assets and liabilities. Our adjustments include prepaid rent, straight-line rent for timing differences between payment streams

and lease term, landlord contributions that are recorded when received as a reduction to the asset, and favorable / unfavorable lease purchase price adjustments. Additionally, upon adoption, we also recorded partial impairments of right-of-use assets with an adjustment to Retained earnings for certain properties.

The interest rates used in our lease contracts are not implicit. We have derived our incremental borrowing rate using the interest rate we would pay on our existing borrowings, adjusted for the effect of designating collateral and the lease terms. The reasonably certain lease term and incremental borrowing rate for each lease requires judgment by management and can impact the classification and accounting for a lease as operating or finance, as well as the value of the lease asset and liability.

The lease asset carrying amounts will be assessed for impairment semi-annually or when events or circumstances indicate that the carrying amount may not be recoverable, in accordance with our long-lived asset impairment policy. We monitor for events or changes in circumstances that require reassessment of lease classification. When a reassessment results in the re-measurement of a lease liability, a corresponding adjustment is made to the carrying amount of the lease asset.

Variable lease costs are expensed as incurred in Restaurant expenses in the Consolidated Statements of Comprehensive Income (Unaudited), and are not included in lease liabilities in the Consolidated Balance Sheets (Unaudited). Contingent rent represents payment of variable lease obligations based on a percentage of sales, as defined by the terms of the applicable lease, for certain restaurant facilities and is recorded at the point in time we determine that it is probable that such sales levels will be achieved. Additionally, we have certain leases which periodically reset to a specified index, such leases are initially recorded using the index that existed at lease commencement. Subsequent index changes are recorded as variable rental payments. Maintenance and property tax expenses are accounted for on an accrual basis as variable lease costs.

We sublease certain leased properties, typically related to closed or refranchised restaurants. The income from the sublease is recorded in Other (income), net in the Consolidated Statements of Comprehensive Income (Unaudited).

Operating lease expenses are recognized on a straight-line basis over the lease term in Restaurant expenses for restaurant facilities, or General and administrative for our corporate headquarters, in the Consolidated Statements of Comprehensive Income (Unaudited), respectively. Operating lease expenses associated with subleased leased properties are recognized on a straight-line basis over the lease term in Other (income), net in the Consolidated Statements of Comprehensive Income (Unaudited).

Finance lease expenses are recognized on a straight-line basis over the lesser of the useful life of the leased asset or the lease term and the expenses are recognized in Depreciation and amortization in the Consolidated Statements of Comprehensive Income (Unaudited). Interest on each finance lease liability is recorded to Interest expenses in the Consolidated Statements of Comprehensive Income (Unaudited).

Financial Statement Impact of ASC 842 Adoption

The adoption of ASC 842 represents a change in accounting principle. The adoption did not have a significant impact on the Consolidated Statements of Comprehensive Income or Consolidated Statements of Cash Flows. Upon adoption, there was a material increase in Total assets and Total liabilities in the Consolidated Balance Sheet primarily due to the recognition of operating lease assets and related lease liabilities where we are the lessee. The table below reflects the balance sheet adoption impact related to ASC 842 as an adjustment at June 27, 2019, the first day of fiscal 2020 (condensed, unaudited):



	Legacy GAAP		ASC 842 Cumulative Adjustments			ASC 842
	June 26, 2019					June 27, 2019
ASSETS
Current assets⁽¹⁾	$	177.0	$	0.3		$	177.3
Other assets
Operating lease assets⁽²⁾	—		1,034.3			1,034.3
Deferred income taxes, net⁽³⁾	112.0		(65.1		)	46.9
Intangibles, net⁽¹⁾	22.3		(4.1		)	18.2
LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current liabilities
Operating lease liabilities⁽⁴⁾	—		110.8			110.8
Other accrued liabilities⁽¹⁾⁽⁵⁾	141.1		(38.3		)	102.8
Long-term operating lease liabilities, less current portion⁽⁴⁾	—		1,044.9			1,044.9
Deferred gain on sale leaseback transactions⁽⁵⁾	255.3		(255.3		)	—
Other liabilities⁽¹⁾	153.0		(92.6		)	60.4
Retained earnings	2,771.2		195.9			2,967.1


⁽¹⁾	The following prior lease balances were reclassified into Operating lease assets upon adoption of ASC 842:


–	Current assets included the prepaid rent adjustment.


–	Intangibles, net included the favorable lease asset position adjustment.


–	Other accrued liabilities and Other liabilities balances related to the current and long-term portions of straight-line rent balances, unfavorable lease liability positions, exit-related lease accruals, and landlord contributions adjustments.

Additionally, Other accrued liabilities included $19.3 million of deferred gain on sale leaseback transactions that was eliminated as a cumulative effect adjustment to Retained earnings upon adoption, refer to ⁽⁵⁾ below for more details. Refer to Note 10 - Accrued and Other Liabilities for June 26, 2019 balance details.

⁽²⁾

Operating lease assets represents the capitalization of operating lease right-of-use assets equal to the amount of recognized operating lease liability as described in ⁽⁴⁾below, adjusted by the net carrying amounts described in ⁽¹⁾ above, and $15.5 million related to certain operating lease assets for restaurant facilities previously fully impaired under our long-lived asset impairment policy that were recorded to Retained earnings.


⁽³⁾	Deferred income taxes, net was reduced by $3.5 million related to the impact of adopting ASC 842 and recording the operating lease assets and liabilities, and $68.6 million related to the elimination of the deferred gain on sale leaseback transactions as described in ⁽⁵⁾below.


⁽⁴⁾	Operating lease liabilities, both current and long-term, represents the liabilities based on the present value of the lease payments, consisting of fixed costs and certain rent escalations, using our incremental borrowing rate applicable to the lease term.

⁽⁵⁾

Deferred gain on sale leaseback transactions balance of $255.3 million and the related short-term deferred gain balance recorded within Other accrued liabilities of $19.3 million, and the associated Deferred income taxes, net of $68.6 million as described in ⁽³⁾ above, were eliminated upon adoption into Retained earnings as required by the new lease accounting standard using the alternative transition method. No further gain will be amortized to Other gains and charges in the Consolidated Statements of Comprehensive Income effective fiscal 2020.

Lease Amounts Included in the Thirteen Week Period Ended September 25, 2019

Consolidated Balance Sheet Disclosure of Lease Amounts

The following table includes a detail of lease asset and liabilities included in the Consolidated Balance Sheets (Unaudited):



	September 25, 2019
	Finance Leases⁽¹⁾		Operating Leases⁽²⁾		Total Leases
Lease assets	$	67.0	$	1,192.3	$	1,259.3

Current lease liabilities	10.2		119.2		129.4
Long-term lease liabilities	73.6		1,189.1		1,262.7
Total lease liabilities	$	83.8	$	1,308.3	$	1,392.1


⁽¹⁾	Finance lease assets are recorded in Property and equipment, at cost, and the related current and long-term lease liabilities are recorded within Other accrued liabilities and Long-term debt and finance leases, less current installments, respectively.


⁽²⁾	Operating lease assets are recorded in Operating lease assets, and the related current and long-term lease liabilities are recorded within Operating lease liabilities and Long-term operating lease liabilities, less current portion, respectively.

Consolidated Statement of Comprehensive Income Disclosure of Lease Amounts

The components of lease expense, including variable lease costs primarily consisting of rent based on a percentage of sales, common area maintenance charges and real estate taxes, and short-term lease expenses for leases with lease terms less than twelve months are included in Consolidated Statements of Comprehensive Income (Unaudited) as follows:



	Thirteen Week Period Ended September 25, 2019
Operating lease cost	$	37.3
Finance lease amortization	2.7
Finance lease interest	0.9
Short-term lease cost	0.2
Variable lease cost	13.3
Sublease (income)	(1.2		)
Total lease costs, net	$	53.2

Consolidated Statement of Cash Flows Disclosure of Lease Amounts

Supplemental cash flow information related to leases recorded in the Consolidated Statements of Cash Flows (Unaudited) is as follows:



	Thirteen Week Period Ended September 25, 2019
Cash flows from operating activities
Cash paid for amounts included in the measurement of lease liabilities
Operating leases	$	40.3
Finance leases	0.9
Cash flows from financing activities
Cash paid for amounts included in the measurement of lease liabilities
Finance leases	2.4
Non-cash lease assets obtained in exchange for new lease liabilities
Operating leases	187.1
Finance leases	37.7

Weighted Average Lease Term and Discount Rate

Other information related to leases is as follows:



	September 25, 2019
	Finance Leases		Operating Leases
Weighted average remaining lease term	11.3 years		12.1 years
Weighted average discount rate	5.4	%	4.3	%

Lease Maturity Analysis

As of September 25, 2019, accounted for and presented under ASC 842 guidance, the future minimum lease payments on finance and operating leases, as well as sublease income were as follows:



	September 25, 2019
Fiscal Year	Finance Leases		Operating Leases		Sublease Income
Remainder of 2020	$	10.9	$	127.7	$	(3.5	)
2021	13.1		170.0		(4.6		)
2022	11.5		161.4		(4.5		)
2023	10.1		150.6		(3.5		)
2024	9.5		140.8		(2.5		)
Thereafter	58.4		969.6		(8.5		)
Total minimum lease payments	113.5		1,720.1		$	(27.1	)
Less: Imputed interest	29.7		411.8
Present value of lease liability	$	83.8	$	1,308.3

As of June 26, 2019, as previously disclosed in our fiscal 2019 Form 10-K under Legacy GAAP, undiscounted future minimum lease payments on both capital and operating leases were as follows:



	June 26, 2019
Fiscal Year	Capital Leases			Operating Leases⁽²⁾
2020	$	12.3		$	156.8
2021	10.1			154.5
2022	8.2			148.6
2023	6.7			137.7
2024	6.0			127.6
Thereafter	17.4			771.7
Total minimum lease payments⁽¹⁾	60.7			$	1,496.9
Imputed interest (average rate of 6.18%)	(12.3		)
Present value of minimum lease payments	48.4
Less current capital lease obligations	(9.7		)
Long-term capital lease obligations	$	38.7


⁽¹⁾	Total minimum lease payments were not reduced by minimum sublease rentals to be received in the future under non-cancelable subleases. The total of undiscounted future sublease rentals was approximately $22.0 million and $14.6 million for capital and operating subleases, respectively, as of June 26, 2019.


⁽²⁾	Operating lease expenses for the fifty-two weeks ended June 26, 2019, recorded under Legacy GAAP, totaled $158.6 million, which included $141.7 million for straight-lined minimum rent, $3.3 million for contingent rent, and $13.6 million of other rent-related expenses.

Significant Changes in Leases during the Period

As part of the Chili’s restaurant acquisition, we assumed and entered into 91 new operating leases included in the balances for the thirteen week period ended September 25, 2019. The leases were recorded net of preliminary purchase price accounting adjustments and prepaid rent. At September 25, 2019, the balances associated with these new leases in the Consolidated Balance Sheets (Unaudited) include Operating lease assets of $172.6 million, Operating lease liabilities of $5.0 million, and Long-term operating lease liabilities, less current portion of $164.5 million.

Additionally related to this transaction, we entered into 11 new finance leases with the initial terms of approximately 11 years, plus renewal options. At September 25, 2019, the balances associated with these finance leases in the Consolidated Balance Sheets (Unaudited) include Buildings and leasehold improvements of $23.7 million, Other accrued liabilities of $0.6 million, and Long-term debt and finance leases, less current installments of $23.0 million. Refer to Note 2 - Chili’s Restaurant Acquisition for information about the acquisition.

Pre-Commencement Leases

In the thirteen week period ended September 25, 2019, we executed one finance lease for Chili’s table-top devices with an initial term of 3 years plus one 3-year renewal option. This lease will commence over the course of fiscal 2020 as we receive the related devices. The undiscounted fixed payments over the initial term, net of lease incentives is $20.4 million. Additionally, we have executed 5 leases for new Chili’s locations with undiscounted fixed payments over the initial term of $15.5 million. These leases are expected to commence during fiscal 2020 and are expected to have an economic lease term of 20 years. These leases will commence when the landlords make the property available to us for new restaurant construction. We will assess the reasonably certain lease term at the lease commencement date.

Fiscal 2019 Sale Leaseback Transactions

Restaurant Properties Sale Leaseback Transactions

In the thirteen week period ended September 26, 2018, we completed sale leaseback transactions of 141 restaurant properties sold for aggregate consideration of $455.7 million. The balances attributable to the restaurant assets sold included Land of $103.6 million, Buildings and leasehold improvements of $217.6 million, certain fixtures included in Furniture and equipment of $9.3 million, and Accumulated depreciation of $163.9 million. The total gain was $289.1 million and the net proceeds from these sale leaseback transactions were used to repay borrowings on our revolving credit facility.

Lease Details

The initial terms of all leases are for 15 years, plus renewal options at our discretion. All of the leases were determined to be operating leases. Rent expenses associated with these operating leases were recognized on a straight-line basis over the lease terms under Legacy GAAP during fiscal 2019. As of June 26, 2019, the straight-line rent accrual balance of $62.3 million was included in Other accrued liabilities (current portion) and Other liabilities (long-term portion) in the Consolidated Balance Sheets (Unaudited) which included $2.8 million of straight-line rent accrual associated with these operating leases. The straight-line rent accrual balance was eliminated upon adoption of ASC 842 effective June 27, 2019, the first day of fiscal 2020, as previously discussed in this footnote.

Gain and Deferred Gain Recognition

We recognized the portion of the gross gain in excess of the present value of the future minimum lease payments, and deferred the remainder of the gain to be recognized straight-line in proportion to the operating lease terms. During the thirteen week period ended September 26, 2018, $20.1 million of the gain was recognized to Other (gains) and charges in the Consolidated Statements of Comprehensive Income (Unaudited). As of June 26, 2019, the remaining balance of the deferred gain of $274.6 million was recorded in Other accrued liabilities (current portion) and Deferred gain on sale leaseback transactions (long-term portion) in the Consolidated Balance Sheets (Unaudited). The deferred gain balance was eliminated through the cumulative effect adjustment to Retained earnings effective June 27, 2019, the first day of fiscal 2020, upon adoption of ASC 842. Refer above for ASC 842 adoption details. For any future sale leaseback transactions under the ASC 842 guidance, the gain, adjusted for any off-market terms, will be recognized immediately in most cases.