Refranchising Initiative

Refranchising Transactions

In June 2016, the Company announced plans to refranchise Company Drive-Ins as part of a refranchising initiative to move toward an approximately 95%-franchised system. During fiscal year 2016, the Company refranchised the operations of 38 Company Drive-Ins. Of the Company Drive-Ins refranchised in fiscal year 2016, 29 were completed as part of the refranchising initiative announced in June 2016. The Company retained a non-controlling minority investment in the franchise operations of 25 of these refranchised drive-ins.

During the first half of fiscal year 2017, the Company completed transactions to refranchise the operations of 110 Company Drive-Ins and retained a non-controlling minority investment in 106 of these refranchised drive-ins. The Company completed the refranchising initiative in the second quarter of fiscal year 2017. All subsequent sales of Company Drive-Ins are considered sales in the normal course of business.

Income from minority investments is included in other revenue on the condensed consolidated statements of income. The gains and losses below associated with refranchised drive-ins are recorded in other operating income, net, on the condensed consolidated statement of income. The following is a summary of the pretax activity recorded as a result of the refranchising initiative (in thousands, except number of refranchised Company Drive-Ins):



	Three months ended May 31, 2017			Nine months ended May 31, 2017
Number of refranchised Company Drive-Ins	—			110

Proceeds from sales of Company Drive-Ins	$	—		$	20,036
Proceeds from sale of real estate ⁽¹⁾	4,749			4,749
Proceeds receivable from sale of real estate ⁽¹⁾	6,977			6,977

Real estate assets sold ⁽¹⁾	(12,095		)	(12,095		)
Assets sold, net of retained minority investment ⁽²⁾	847			(7,891		)
Initial and subsequent lease payments for real estate option ⁽¹⁾	195			(3,201		)
Goodwill related to sales of Company Drive-Ins	—			(966		)
Deferred gain for real estate option ⁽³⁾	141			(899		)
Gain (loss) on assets held for sale	—			(65		)
Refranchising initiative gains (losses), net	$	814		$	6,645

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(1)

During the first quarter of fiscal year 2017, as part of a 53 drive-in refranchising transaction, the Company entered into a direct financing lease which included an option for the franchisee to purchase the real estate within the next 24 months. In accordance with lease accounting requirements, because the exercise of this option could occur at any time within 24 months, the portion of the proceeds from the refranchising attributable to the fair value of the option was applied as the initial minimum lease payment for the real estate. The franchisee initiated exercise of a portion of the option during the third fiscal quarter, resulting in a loss of $0.4 million. A portion of the proceeds were received subsequent to the end of the quarter. Until the option is fully exercised, the franchisee is making monthly lease payments which totaled $0.2 million for the third fiscal quarter, net of sub-lease expense, and is included in other operating income.


(2)	Net assets sold consisted primarily of equipment. During the third quarter of fiscal year 2017, the Company made an adjustment to retained minority investment.


(3)	The deferred gain of $0.9 million is recorded in other non-current liabilities as a result of a real estate purchase option extended to the franchisee in the second quarter of fiscal year 2017. The deferred gain will continue to be amortized into income through January 2020 when the option becomes exercisable.



	Refranchising Initiative Fiscal Year 2016
Number of refranchised Company Drive-Ins ⁽¹⁾	29

Proceeds from sales of Company Drive-Ins	$	3,568

Assets sold, net of retained minority investment ⁽²⁾	(2,402		)
Goodwill related to sales of Company Drive-Ins	(194		)
Refranchising initiative gains (losses), net	$	972

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(1)	Company Drive-Ins refranchised as part of the refranchising initiative announced in June 2016.


(2)	Net assets sold consisted primarily of equipment.

Direct Financing Leases

As part of the refranchising initiative, the Company entered into direct franchising leases in fiscal year 2016 and the first half of fiscal year 2017. Components of net investment in direct financing leases as of May 31, 2017 are as follows:



	May 31, 2017			August 31, 2016
Minimum lease payments receivable	$	18,043		$	15,108
Less unearned income	(6,115		)	(5,134		)
Net investment in direct financing lease	11,928			9,974
Less amount due within one year	(317		)	(115		)
Amount due after one year	$	11,611		$	9,859

Future minimum rental payments receivable as of May 31, 2017 are as follows:



	Direct Financing Lease
Years ended August 31:
2017	$	257
2018	1,048
2019	1,117
2020	1,230
2021	1,326
Thereafter	13,065
	18,043
Less unearned income	(6,115		)
	$	11,928

Initial direct costs incurred in the negotiation and consummation of direct financing lease transactions have not been material. Accordingly, no portion of unearned income has been recognized to offset those costs.

Assets Held for Sale

Assets held for sale as of May 31, 2017 totaled $7.5 million and consist of real estate that is expected to sell within one year as part of the real estate options extended to franchisees in connection with the Company’s refranchising initiatives. Such assets are classified as assets held for sale upon meeting the requirements of ASC 360, “Accounting for the Impairment or Disposal of Long-Lived Assets” and are included in prepaid and other current assets on the Company's condensed consolidated balance sheet. These assets are recorded at the lower of the carrying amounts or fair values less costs to sell. Assets held for sale totaled $5.3 million at August 31, 2016 and consisted of Company Drive-In operations included in the refranchising initiative.