Chili's Resturant Owners Resolve Tip Reporting Dispute with IRS
Brinker International, Inc., recently announced that it has resolved its previously disclosed dispute with the Internal Revenue Service (IRS) concerning the Tip Reporting Alternative Commitment (TRAC) agreement.
Brinker paid an assessment of $17.3 million in December 2004 for employer- only Federal Insurance Contributions Act (FICA) taxes on unreported cash tips for calendar years 2000 through 2002. The company will record the $17.3 million payment in restaurant expenses in the second quarter of fiscal 2005 and expects to record an income tax benefit of approximately $16.9 million, consisting primarily of federal income tax credits related to excess FICA taxes. This will result in a negative impact on net income of approximately $400,000 in the second quarter of fiscal 2005.
Brinker continues to believe that it was in full compliance with the TRAC agreement and that the IRS' retroactive revocation was unjustified, particularly in light of compliance reviews conducted by the IRS prior to the revocation. Nevertheless, the company has agreed to the resolution to avoid potentially costly and protracted litigation.
The company further stated that due to the IRS' current interpretation of the TRAC program, it will not seek to reinstate the agreement.
Following a review of its accounting policy and in consultation with its independent registered public accounting firm, KPMG LLP, the company has corrected its computation of straight-line rent expense and the related deferred rent liability. This move is similar to recent restatements announced by other KPMG client restaurant companies.
Historically, when accounting for leases with renewal options, rent expense has been recorded on a straight-line basis over the initial non- cancelable lease term. Buildings and leasehold improvements on those properties are depreciated over a period equal to the shorter of the term of the lease -- including option periods provided for in the lease -- or the useful life of the assets. Brinker will recognize rent expense on a straight- line basis over sufficient renewal periods to equal the depreciable life of 20 years, including cancelable option periods where failure to exercise such options would result in an economic penalty.
Brinker also evaluated the accounting of an intangible asset related to franchise rights acquired in fiscal 1998 and has determined that it would have been more appropriate to expense the purchase price of the franchise rights.
As a result of the above items, Brinker will restate its financial statements through the first quarter of fiscal 2005. The company estimates that the cumulative effect of the restatement through fiscal 2004 will be an increase in the deferred rent liability of approximately $20.7 million and a decrease in intangible franchise rights of $4.4 million. In addition, the deferred income tax liability at the end of fiscal 2004 will decrease by approximately $9.4 million, and retained earnings at the end of fiscal 2004 will decrease by approximately $15.7 million. Rent expense for fiscal years ended 2002, 2003 and 2004 will increase by approximately $3.3 million, $3.9 million and $4.9 million, respectively, and for the first quarter of fiscal 2005 by approximately $1.3 million.
The restatement will decrease diluted net earnings per share by approximately $0.02, $0.02 and $0.03 for the fiscal years ended 2002, 2003 and 2004, respectively, and approximately $0.01 for the first quarter of fiscal 2005. The restatement will not have any impact on the company's previously reported cash flows, sales or comparable store sales or compliance with any covenant under its credit facility or other debt instruments.
These estimates are subject to change as the company's independent registered public accounting firm completes its review. The company will amend the appropriate filings with the Securities and Exchange Commission to include the restated financial statements. As a result of the restatement, the financial statements contained in the company's prior filings with the SEC should no longer be relied upon.
As a result of the change in straight-line rent accounting and the IRS resolution, the company now expects that its second quarter and fiscal 2005 net earnings and earnings per diluted share estimates will be reduced by approximately $1.2 million and $3.8 million, and approximately $0.01 and $0.04, respectively. Accordingly, the company's current estimates of earnings per diluted share are now approximately $0.44 to $0.46 for the second quarter and approximately $2.02 to $2.15 for fiscal 2005. The fiscal 2005 estimates include the impact of EITF 04-8, exclude impairments and lease obligation charges associated with Big Bowl and Rockfish, and exclude potential refranchising gains.