LEASES

9 Months Ended

Nov. 03, 2019

LEASES

LEASES

NOTE 6 – LEASES

The Company adopted ASU No. 2016-02, “Leases (Topic 842),” and its related amendments (collectively “ASC 842”) on February 4, 2019 (the first day of fiscal 2019) using the cumulative adjustment transition method. The standard requires lessees to recognize a right-of-use (“ROU”) asset and lease liability for all leases.

At adoption of ASC 842, the Company recognized ROU assets for operating leases of approximately $430 million and operating lease liabilities of approximately $447 million, the difference attributable to the reclassification of prepaid rent and accrued rent balances outstanding at adoption into the ROU assets and the cumulative adjustment recorded to the opening balance of retained earnings. The cumulative adjustment, net of tax, recorded to the opening balance of retained earnings was $3 million. The Company’s finance leases are immaterial. The adoption of ASC 842 did not have a material impact on the Company’s income statement. The Company’s consolidated financial statements for the three and nine months ended November 3, 2019 are presented under ASC 842, while comparative periods presented have not been adjusted and continue to be reported in accordance with the previous standard, ASC 840, “Leases.”

The Company elected the package of practical expedients for existing contracts permitted under the transition guidance within ASC 842, which includes not reassessing lease classification of existing leases, the historical assessment of whether contracts are or contain leases, and the determination of initial direct costs. The Company did not elect the hindsight practical expedient.

Lease Accounting Policies and Disclosures

The Company determines if an agreement is a lease upon inception. An agreement is or contains a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The right to control the use of an asset includes the right to obtain substantially all of the economic benefits of the underlying asset and the right to direct how and for what purpose the asset is used.

The Company has operating leases for distribution centers, warehouses, office space, and transportation vehicles. The Company has an immaterial amount of financing leases for other equipment. Certain leases for real estate contain options to extend or terminate the lease. Determining the lease term and amount of lease payments to include in the calculation of the ROU asset and lease liability for leases containing options requires the use of judgment to determine whether the exercise of an option is reasonably certain, and if the option period and payments should be included in the calculation of the associated ROU asset and liability. In making this determination, the Company considers all relevant economic factors that would compel the Company to exercise or not exercise an option.

Many of the Company’s real estate leases contain charges for common area maintenance or other miscellaneous expenses that are updated based on landlord estimates. The Company determined these charges are variable non-lease components and did not elect the practical expedient to combine with lease components. Additionally, many of the Company’s transportation equipment leases require additional payments based on the underlying usage of the assets. Certain lease agreements include rental payments adjusted annually based on changes in an inflation index. Due to the variable nature of these costs, the cash flows associated with these charges are expensed as incurred and not included in the lease payments used to determine the ROU asset and associated lease liability.

Lease ROU assets and associated liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. The Company’s leases generally do not provide a readily determinable implicit borrowing rate. As such, the discount rate used to calculate present value is the Company’s collateralized incremental borrowing rate. The  collateralized incremental borrowing rate for each lease varies in accordance with the lease term. Lease expense is recognized on a straight-line basis over the lease term.

The following components of lease expense are included in Selling, general, and administrative expenses on the Consolidated Statement of Operations for the three and nine months ended November 3, 2019 (dollars in millions):

	Three Months Ended		Nine Months Ended
	November 3, 2019		November 3, 2019
Operating Lease Cost	$	35	$	106
Short-term Lease Cost		2		4
Variable Lease Cost		2		4
Sublease Income		(1)		(3)
Total Lease Cost	$	38	$	111

Lease costs associated with finance leases are immaterial for the Company.

As of November 3, 2019, the weighted average remaining lease term for operating leases is 5.1 years and the weighted average discount rate is 4.66%.

During the nine months ended November 3, 2019, the Company’s cash flows from operating activities included $116 million of cash payments for amounts included in the measurement of operating lease liabilities. During the nine months ended November 3, 2019, the Company obtained ROU assets of $83 million in exchange for operating lease liabilities.

As of November 3, 2019, maturities of operating lease liabilities were as follows (amounts in millions):

	Fiscal Year
	Remainder
	of 2019		2020		2021		2022		2023		Thereafter		Total
Operating Lease Payments	$	35		118		108		80		59		97	$	497
Less imputed interest														59
Total Discounted Lease Liability													$	438

As of November 3, 2019, the Company has additional leases which have not yet commenced, but are anticipated to commence in fiscal 2019. Commencement occurs when the Company is granted access to the property, such as when leasehold improvements are completed by the lessor or a certificate of occupancy is obtained. The Company anticipates these leases will result in approximately $40 million of ROU assets obtained in exchange for lease liabilities.

Disclosure related to periods prior to adoption of ASC 842:

Rental expense under operating leases was $142 million, $127 million, and $118 million in fiscal 2018, fiscal 2017, and fiscal 2016, respectively. Rental expense under operating leases for the three and nine months ended October 28, 2018 was $36 million and $104 million, respectively.

As of February 3, 2019, future minimum aggregate rental payments under non-cancelable leases were as follows (amounts in millions):

	Fiscal Year
	2019		2020		2021		2022		2023		Thereafter		Total
Operating Leases	$	140		104		88		61		42		78	$	513

Corporate headquarters

In February 2016, the Company entered into a build-to-suit arrangement for a leadership development and headquarters facility in Atlanta, Georgia, which began construction in 2016. In accordance with ASC 840, for build-to-suit arrangements where the Company is involved in the construction of structural improvements prior to the commencement of the lease or takes some level of construction risk, the Company was considered the owner of the assets and land during the construction period. Accordingly, during construction activities, the Company recorded a Construction in progress asset within Property and equipment and a corresponding financing liability on the Consolidated Balance Sheet for construction costs incurred by the landlord.

The lease commenced in February 2018, with the leased asset and corresponding financing liability valued at $87 million each. In accordance with the sale and leaseback criteria of GAAP, the build-to-suit arrangement and subsequent lease failed to qualify as a sale. Therefore, the transaction was accounted for as a financing arrangement, whereby both the leased asset and the financing liability remained on the Company’s Consolidated Balance Sheet. The asset was depreciated as if the Company was the legal owner and rental payments were allocated between interest expense and principal repayment of the financing liability.

The Company exercised its option to purchase the leased asset, completing the purchase on February 4, 2019 for a total purchase price of $88 million. As the purchase option was executed on the first day of fiscal 2019, the Company did not recognize an ROU asset for the finance lease and a corresponding lease liability as part of the adoption of ASC 842 and excluded the future minimum rental payments from the commitment tables disclosed above.