XNYS:DRI Darden Restaurants Inc Quarterly Report 10-Q Filing - 2/26/2012

Effective Date 2/26/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 (Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 26, 2012
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
1-13666
Commission File Number
 DARDEN RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
 
Florida
 
59-3305930
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
1000 Darden Center Drive
Orlando, Florida
 
32837
(Address of principal executive offices)
 
(Zip Code)
407-245-4000
(Registrant’s telephone number, including area code)
Not applicable (Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    o  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    o  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
x
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    o  Yes    x  No
Number of shares of common stock outstanding as of March 15, 2012: 128,653,628 (excluding 159,870,784 shares held in our treasury).



TABLE OF CONTENTS
 
 
 
 
Page
Part I -
Financial Information
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
Part II -
Other Information
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 4.
 
Item 6.
 
 
 
 

2


Cautionary Statement Regarding Forward-Looking Statements
Statements set forth in or incorporated into this report regarding the expected net increase in the number of our restaurants, U.S. same-restaurant sales, total sales growth, diluted net earnings per share growth, and capital expenditures in fiscal 2012, and all other statements that are not historical facts, including without limitation statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Darden Restaurants, Inc. and its subsidiaries that are preceded by, followed by or that include words such as “may,” “will,” “expect,” “intend,” “anticipate,” “continue,” “estimate,” “project,” “believe,” “plan” or similar expressions, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This statement is included for purposes of complying with the safe harbor provisions of that Act. Any forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update such statements for any reason to reflect events or circumstances arising after such date. By their nature, forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by such forward-looking statements. For further information regarding such forward-looking statements, risks and uncertainties, please see “Forward-Looking Statements” under Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report.

3


PART I
FINANCIAL INFORMATION
Item  1. Financial Statements (Unaudited)
DARDEN RESTAURANTS, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(In millions, except per share data)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
February 26,
2012
 
February 27,
2011
 
February 26,
2012
 
February 27,
2011
Sales
$
2,159.7

 
$
1,976.8

 
$
5,933.2

 
$
5,509.8

Costs and expenses:
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Food and beverage
661.7

 
571.3

 
1,828.5

 
1,573.5

Restaurant labor
657.2

 
621.2

 
1,864.6

 
1,771.9

Restaurant expenses
308.4

 
285.9

 
901.2

 
839.9

Total cost of sales, excluding restaurant depreciation and amortization of $83.2, $74.5, $242.2 and $219.0, respectively
$
1,627.3

 
$
1,478.4

 
$
4,594.3

 
$
4,185.3

Selling, general and administrative
198.0

 
194.8

 
568.3

 
555.9

Depreciation and amortization
88.9

 
80.5

 
258.8

 
235.2

Interest, net
27.7

 
24.0

 
74.5

 
72.1

Total costs and expenses
$
1,941.9

 
$
1,777.7

 
$
5,495.9

 
$
5,048.5

Earnings before income taxes
217.8

 
199.1

 
437.3

 
461.3

Income taxes
(53.7
)
 
(47.4
)
 
(112.3
)
 
(120.5
)
Earnings from continuing operations
$
164.1

 
$
151.7

 
$
325.0

 
$
340.8

Losses from discontinued operations, net of tax benefit of $0.0, $0.3, $0.4 and $1.2, respectively

 
(0.5
)
 
(0.7
)
 
(2.0
)
Net earnings
$
164.1

 
$
151.2

 
$
324.3

 
$
338.8

Basic net earnings per share:
 
 
 
 

 

Earnings from continuing operations
$
1.28

 
$
1.11

 
$
2.49

 
$
2.48

Losses from discontinued operations

 

 
(0.01
)
 
(0.02
)
Net earnings
$
1.28

 
$
1.11

 
$
2.48

 
$
2.46

Diluted net earnings per share:
 
 
 
 

 

Earnings from continuing operations
$
1.25

 
$
1.08

 
$
2.43

 
$
2.42

Losses from discontinued operations

 

 
(0.01
)
 
(0.02
)
Net earnings
$
1.25

 
$
1.08

 
$
2.42

 
$
2.40

Average number of common shares outstanding:
 
 
 
 

 

Basic
128.0

 
136.4

 
130.7

 
137.5

Diluted
130.9

 
140.0

 
133.8

 
141.0

Dividends declared per common share
$
0.43

 
$
0.32

 
$
1.29

 
$
0.96


See accompanying notes to our unaudited consolidated financial statements.

4


DARDEN RESTAURANTS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions)
 
 
February 26,
2012
 
May 29,
2011
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
88.5

 
$
70.5

Receivables, net
55.5

 
65.4

Inventories
453.6

 
300.1

Prepaid income taxes
13.2

 
5.2

Prepaid expenses and other current assets
69.0

 
77.0

Deferred income taxes
125.5

 
145.6

Total current assets
$
805.3

 
$
663.8

Land, buildings and equipment, net of accumulated depreciation and amortization of $2,717.4 and $2,545.4, respectively
3,882.9

 
3,622.0

Goodwill
539.2

 
517.1

Trademarks
464.8

 
454.0

Other assets
235.2

 
209.7

Total assets
$
5,927.4

 
$
5,466.6

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
294.1

 
$
251.3

Short-term debt
287.7

 
185.5

Accrued payroll
158.6

 
167.1

Accrued income taxes
1.4

 
9.3

Other accrued taxes
72.0

 
64.3

Unearned revenues
267.3

 
200.0

Current portion of long-term debt
349.9

 

Other current liabilities
467.3

 
409.3

Total current liabilities
$
1,898.3

 
$
1,286.8

Long-term debt, less current portion
1,452.8

 
1,407.3

Deferred income taxes
329.1

 
345.4

Deferred rent
199.6

 
186.2

Obligations under capital leases, net of current installments
54.8

 
56.0

Other liabilities
216.5

 
248.7

Total liabilities
$
4,151.1

 
$
3,530.4

Stockholders’ equity:
 
 
 
Common stock and surplus
$
2,483.7

 
$
2,408.8

Retained earnings
3,077.2

 
2,921.9

Treasury stock
(3,679.2
)
 
(3,325.3
)
Accumulated other comprehensive income (loss)
(97.5
)
 
(59.8
)
Unearned compensation
(7.9
)
 
(9.4
)
Total stockholders’ equity
$
1,776.3

 
$
1,936.2

Total liabilities and stockholders’ equity
$
5,927.4

 
$
5,466.6


See accompanying notes to our unaudited consolidated financial statements.


5


DARDEN RESTAURANTS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
For the nine months ended February 26, 2012 and February 27, 2011
(In millions)
(Unaudited)
 
 
Common
Stock
And
Surplus
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Unearned
Compensation
 
Total
Stockholders’
Equity
Balance at May 29, 2011
$
2,408.8

 
$
2,921.9

 
$
(3,325.3
)
 
$
(59.8
)
 
$
(9.4
)
 
$
1,936.2

Comprehensive income:

 

 

 

 

 

Net earnings

 
324.3

 

 

 

 
324.3

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency adjustment

 

 

 
(0.5
)
 

 
(0.5
)
Change in fair value of marketable securities, net of tax of $0.1

 

 

 
(0.1
)
 

 
(0.1
)
Change in fair value of derivatives, net of tax of $25.0

 

 

 
(42.5
)
 

 
(42.5
)
Amortization of unrecognized net actuarial loss, net of tax of $3.3

 

 

 
5.4

 

 
5.4

Total comprehensive income

 

 

 

 

 
286.6

Dividends declared

 
(169.0
)
 

 

 

 
(169.0
)
Stock option exercises (1.4 shares)
37.7

 

 
2.2

 

 

 
39.9

Stock-based compensation
20.5

 

 

 

 

 
20.5

ESOP note receivable repayments

 

 

 

 
1.5

 
1.5

Income tax benefits credited to equity
12.0

 

 

 

 

 
12.0

Purchases of common stock for treasury (7.9 shares)

 

 
(357.0
)
 

 

 
(357.0
)
Issuance of treasury stock under Employee Stock Purchase Plan and other plans (0.1 shares)
4.7

 

 
0.9

 

 

 
5.6

Balance at February 26, 2012
$
2,483.7

 
$
3,077.2

 
$
(3,679.2
)
 
$
(97.5
)
 
$
(7.9
)
 
$
1,776.3

 
 
 
 
 
 
 
 
 
 
 
 
Balance at May 30, 2010
$
2,297.9

 
$
2,621.9

 
$
(2,943.5
)
 
$
(71.1
)
 
$
(11.2
)
 
$
1,894.0

Comprehensive income:

 

 

 

 

 

Net earnings

 
338.8

 

 

 

 
338.8

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency adjustment

 

 

 
1.7

 

 
1.7

Change in fair value of marketable securities, net of tax of $0.0

 

 

 
0.1

 

 
0.1

Change in fair value of derivatives, net of tax of $1.1

 

 

 
3.2

 

 
3.2

Amortization of unrecognized net actuarial loss, net of tax of $3.0

 

 

 
4.7

 

 
4.7

Total comprehensive income

 

 

 

 

 
348.5

Dividends declared

 
(132.5
)
 

 

 

 
(132.5
)
Stock option exercises (1.8 shares)
42.4

 

 
1.8

 

 

 
44.2

Stock-based compensation
25.3

 

 

 

 

 
25.3

ESOP note receivable repayments

 

 

 

 
1.5

 
1.5

Income tax benefits credited to equity
12.7

 

 

 

 

 
12.7

Purchases of common stock for treasury (6.3 shares)

 

 
(275.9
)
 

 

 
(275.9
)
Issuance of treasury stock under Employee Stock Purchase Plan and other plans (0.2 shares)
4.8

 

 
0.9

 

 

 
5.7

Balance at February 27, 2011
$
2,383.1

 
$
2,828.2

 
$
(3,216.7
)
 
$
(61.4
)
 
$
(9.7
)
 
$
1,923.5


See accompanying notes to our unaudited consolidated financial statements.


6


DARDEN RESTAURANTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
 
Nine Months Ended
 
February 26,
2012
 
February 27,
2011
Cash flows—operating activities
 
 
 
Net earnings
$
324.3

 
$
338.8

Losses from discontinued operations, net of tax benefit
0.7

 
2.0

Adjustments to reconcile net earnings from continuing operations to cash flows:
 
 
 
Depreciation and amortization
258.8

 
235.2

Asset impairment charges
0.3

 
4.3

Amortization of loan costs
4.4

 
2.2

Stock-based compensation expense
41.3

 
48.7

Change in current assets and liabilities
(101.4
)
 
28.2

Contributions to pension and postretirement plans
(22.7
)
 
(11.9
)
Loss on disposal of land, buildings and equipment
4.9

 
4.8

Change in cash surrender value of trust-owned life insurance
0.1

 
(12.6
)
Deferred income taxes
23.7

 
28.2

Change in deferred rent
13.7

 
13.2

Change in other liabilities
(1.2
)
 
(21.2
)
Income tax benefits from exercise of stock-based compensation credited to goodwill
0.3

 
0.2

Other, net
3.3

 
2.6

Net cash provided by operating activities of continuing operations
$
550.5

 
$
662.7

Cash flows—investing activities
 
 
 
Purchases of land, buildings and equipment
(483.4
)
 
(390.1
)
Proceeds from disposal of land, buildings and equipment
3.3

 
5.8

Purchases of marketable securities
(32.1
)
 
(2.3
)
Proceeds from sale of marketable securities
21.3

 
4.6

Cash used in business acquisitions, net of cash acquired
(58.6
)
 

Increase in other assets
(10.3
)
 
(8.5
)
Net cash used in investing activities of continuing operations
$
(559.8
)
 
$
(390.5
)
Cash flows—financing activities
 
 
 
Proceeds from issuance of common stock
45.1

 
49.9

Income tax benefits credited to equity
12.0

 
12.7

Dividends paid
(168.6
)
 
(132.0
)
Purchases of treasury stock
(357.0
)
 
(275.9
)
ESOP note receivable repayment
1.5

 
1.5

Proceeds from issuance of short-term debt
1,791.7

 
920.4

Repayments of short-term debt
(1,689.5
)
 
(856.4
)
Repayment of long-term debt
(1.5
)
 
(151.5
)
Principal payments on capital leases
(1.2
)
 
(1.0
)
Proceeds from issuance of long-term debt
400.0

 

Payment of debt issuance costs
(5.1
)
 

Net cash provided by (used in) financing activities of continuing operations
$
27.4

 
$
(432.3
)
Cash flows—discontinued operations
 
 
 
Net cash used in operating activities of discontinued operations
(0.4
)
 
(2.1
)
Net cash provided by investing activities of discontinued operations
0.3

 
3.1

Net cash (used in) provided by discontinued operations
$
(0.1
)
 
$
1.0

 
 
 
 
Increase (decrease) in cash and cash equivalents
18.0

 
(159.1
)
Cash and cash equivalents - beginning of period
70.5

 
248.8

Cash and cash equivalents - end of period
$
88.5

 
$
89.7

Cash flows from changes in current assets and liabilities
 
 
 
Receivables, net
9.9

 
(19.5
)
Inventories
(152.5
)
 
(106.1
)
Prepaid expenses and other current assets
(3.3
)
 
(10.9
)
Accounts payable
28.9

 
24.2

Accrued payroll
(9.0
)
 
(0.5
)
Prepaid/accrued income taxes
(15.9
)
 
(3.2
)
Other accrued taxes
7.7

 
4.5

Unearned revenues
66.7

 
62.3

Other current liabilities
(33.9
)
 
77.4

Change in current assets and liabilities
$
(101.4
)
 
$
28.2

See accompanying notes to our unaudited consolidated financial statements.


7

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 



Note 1.Basis of Presentation
Darden Restaurants, Inc. (we, our or the Company) owns and operates full-service dining restaurants in the United States and Canada under the trade names Red Lobster®, Olive Garden®, LongHorn Steakhouse®, The Capital Grille®, Bahama Breeze®, Seasons 52®, Eddie V's Prime Seafood® and Wildfish Seafood Grille®. We have prepared these consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally presented in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. Operating results for the quarter ended February 26, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending May 27, 2012.
These statements should be read in conjunction with the consolidated financial statements and related notes to consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 29, 2011. The accounting policies used in preparing these consolidated financial statements are the same as those described in our Form 10-K.
We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of sales and costs and expenses during the reporting period. Actual results could differ from those estimates. We have reclassified certain amounts in the prior-period consolidated statement of cash flows to conform to the current period’s presentation.
Unless otherwise noted, amounts and disclosures throughout the notes to consolidated financial statements relate to our continuing operations.

Unearned Revenues
Unearned revenues represent our liability for gift cards that have been sold but not yet redeemed.  We recognize sales from our gift cards when the gift card is redeemed by the customer.  Although there are no expiration dates or dormancy fees for our gift cards, based on our analysis of our historical gift card redemption patterns, we can reasonably estimate the amount of gift cards for which redemption is remote, which is referred to as “breakage”.  We recognize breakage within sales for unused gift card amounts in proportion to actual gift card redemptions, which is also referred to as the “redemption recognition” method.  The estimated value of gift cards expected to remain unused is recognized over the expected period of redemption as the remaining gift card values are redeemed, generally over a period of 10 years.  Utilizing this method, we estimate both the amount of breakage and the time period of redemption.  If actual redemption patterns vary from our estimates, actual gift card breakage income may differ from the amounts recorded.  We update our estimates of our redemption period and our breakage rate periodically and apply that rate to gift card redemptions. 
Acquisition of Eddie V's
On November 14, 2011, we completed the acquisition of eight Eddie V's Prime Seafood restaurants and three Wildfish Seafood Grille restaurants (collectively Eddie V's) and all related assets and net working capital for $58.6 million in cash. The results of operations from Eddie V's, which are not material, are included in our consolidated financial statements from the date of acquisition.
The acquisition resulted in the recording of depreciable assets, definite-lived amortizable intangible assets and indefinite-lived intangible assets, including goodwill. We are in the process of confirming, through internal studies and third-party valuations, the fair value of these assets, including buildings and equipment and intangible assets. The fair values set forth below are based on preliminary valuations and are subject to adjustment as additional information is obtained. When the valuation process is completed, adjustments to goodwill may result.

8

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


The following table summarizes the preliminary estimated fair values of the Eddie V's assets acquired and liabilities assumed as of the acquisition date and the adjustments made thereto during the fiscal quarter ended February 26, 2012:

 
 
Balances at
 
 
 
Balances at
(in millions)
 
November 14, 2011
 
Adjustments
 
February 26, 2012
Current assets
 
$
1.7

 
$
(0.1
)
 
$
1.6

Buildings and equipment
 
26.8

 
0.4

 
27.2

Trademarks
 
17.0

 
(6.2
)
 
10.8

Other assets
 
2.9

 
(0.4
)
 
2.5

Goodwill
 
16.6

 
5.7

 
22.3

     Total assets acquired
 
$
65.0

 
$
(0.6
)
 
$
64.4

Current liabilities
 
4.5

 

 
4.5

Other liabilities
 
1.3

 

 
1.3

     Total liabilities assumed
 
$
5.8

 
$

 
$
5.8

Net assets acquired
 
$
59.2

 
$
(0.6
)
 
$
58.6


Adjustments to the preliminary purchase price allocation during the quarter ended February 26, 2012 were primarily related to updated valuations in the preliminary appraisals of identifiable intangible and tangible assets.
The excess of the purchase price over the aggregate fair value of net assets acquired was allocated to goodwill, all of which is expected to be deductible for tax purposes. Trademarks primarily have an indefinite life based on the expected use of the assets and the regulatory and economic environment within which they are being used. These trademarks represent highly respected brands with positive connotations and we intend to cultivate and protect the use of these brands. Goodwill and indefinite-lived trademarks are not amortized but are reviewed annually for impairment or more frequently if indicators of impairment exist. Buildings and equipment will be depreciated over a period of 5 months to 23 years. Other assets and liabilities represent value associated with favorable and unfavorable market leases and will be amortized over a weighted average period of 16 years.
As a result of the acquisition and related integration efforts, we incurred expenses of approximately $1.1 million and $2.4 million during the quarter and nine months ended February 26, 2012, respectively, which are included in selling, general and administrative expenses in our consolidated statements of earnings. Pro-forma financial information of the combined entities for periods prior to the acquisition is not presented due to the immaterial impact of the financial results of Eddie V's on our consolidated financial statements.

Note 2.Supplemental Cash Flow Information
 
 
Nine Months Ended
(in millions)
 
February 26, 2012
 
February 27, 2011
Interest paid, net of amounts capitalized
 
$
51.0

 
$
59.6

Income taxes paid, net of refunds
 
92.0

 
90.7



9

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


Note 3.Stock-Based Compensation
We grant stock options for a fixed number of shares to certain employees and directors with an exercise price equal to the fair value of the shares at the date of grant. We also grant restricted stock, restricted stock units, and performance stock units with a fair value determined based on our closing stock price on the date of grant. In addition, we also grant cash settled stock units (Darden Stock Units) and cash settled performance stock units, which are classified as liabilities and are marked to market as of the end of each period. The weighted-average fair value of non-qualified stock options and the related assumptions used in the Black-Scholes option pricing model were as follows: 
 
Stock Options Granted
During the Nine Months Ended
 
February 26, 2012
 
February 27, 2011
Weighted-average fair value
$
14.32

 
$
12.84

Dividend yield
3.53
%
 
3.01
%
Expected volatility of stock
39.4
%
 
39.1
%
Risk-free interest rate
2.10
%
 
2.21
%
Expected option life (in years)
6.5

 
6.7

 
The following table presents a summary of our stock-based compensation activity for the nine months ended February 26, 2012: 
(in millions)
 
Stock
Options
 
Restricted
Stock/
Restricted
Stock
Units
 
Darden
Stock
Units
 
Performance
Stock Units
Outstanding beginning of period
 
13.0

 
0.6

 
1.9

 
1.0

Awards granted
 
1.6

 
0.1

 
0.6

 
0.3

Awards exercised
 
(1.4
)
 
(0.4
)
 
(0.3
)
 
(0.2
)
Awards forfeited
 
(0.1
)
 

 
(0.1
)
 

Outstanding end of period
 
13.1

 
0.3

 
2.1

 
1.1

We recognized expense from stock-based compensation as follows: 
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
February 26,
2012
 
February 27,
2011
 
February 26,
2012
 
February 27,
2011
Stock options
 
$
4.8

 
$
5.1

 
$
14.5

 
$
15.1

Restricted stock/restricted stock units
 
0.9

 
3.1

 
3.5

 
7.4

Darden stock units
 
6.0

 
2.9

 
11.1

 
11.1

Performance stock units
 
4.4

 
5.8

 
9.6

 
12.2

Employee stock purchase plan
 
0.5

 
0.6

 
1.4

 
1.5

Director compensation program/other
 

 
0.1

 
1.2

 
1.4

Total stock-based compensation expense
 
$
16.6

 
$
17.6

 
$
41.3

 
$
48.7


Note 4.Income Taxes
The effective income tax rate for the quarter and nine months ended February 26, 2012 was 24.7 percent and 25.7 percent, respectively, compared to an effective income tax rate of 23.8 percent and 26.1 percent for the quarter and nine months ended February 27, 2011, respectively. The increase in the effective income tax rate for the quarter ended February 26, 2012 as compared to the quarter ended February 27, 2011 is primarily attributable to the fiscal 2011 impact of the favorable resolution of prior year tax matters expensed in prior years in addition to the impact of market-driven changes in the value of our trust-owned life insurance that are excluded for tax purposes, partially offset by an increase in federal income tax credits related to the Hiring Incentives to Restore Employment (HIRE) Act, an increase in the impact of FICA tax credits for employee reported

10

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


tips and the impact of solar energy tax credits. The decrease in the effective income tax rate during the nine months ended February 26, 2012 as compared to the nine months ended February 27, 2011 is primarily attributable to an increase in federal income tax credits related to the HIRE Act, an increase in the impact of FICA tax credits for employee reported tips and the impact of solar energy tax credits, partially offset by the fiscal 2011 impact of the favorable resolution of prior year tax matters expensed in prior years in addition to the impact of market-driven changes in the value of our trust-owned life insurance that are excluded for tax purposes.
Included in our remaining balance of unrecognized tax benefits is $1.6 million related to tax positions for which it is reasonably possible that the total amounts could change within the next twelve months based on the outcome of examinations or as a result of the expiration of the statute of limitations for specific jurisdictions.

Note 5.Long-Term Debt

Until October 3, 2011, we maintained a $750.0 million revolving Credit Agreement dated September 20, 2007 (Prior Revolving Credit Agreement) with Bank of America, N.A. (BOA), as administrative agent, and the lenders and other agents party thereto. The Prior Revolving Credit Agreement was a senior unsecured credit commitment to the Company and contained customary representations, affirmative and negative covenants (including limitations on liens and subsidiary debt and a maximum consolidated lease adjusted total debt to total capitalization ratio of 0.75 to 1.00) and events of default usual for credit facilities of this type. The Prior Revolving Credit Agreement also contained a sub-limit of $150.0 million for the issuance of letters of credit. The Prior Revolving Credit Agreement supported our commercial paper borrowing program and would have matured on September 20, 2012, but was terminated on October 3, 2011 when we entered into the new credit arrangements described below and repaid all amounts that were outstanding under the Prior Revolving Credit Agreement.

On October 3, 2011, we entered into a new $750.0 million revolving Credit Agreement (New Revolving Credit Agreement) with BOA, as administrative agent, and the lenders (New Revolving Credit Lenders) and other agents party thereto. The New Revolving Credit Agreement is a senior unsecured credit commitment to the Company and contains customary representations and affirmative and negative covenants (including limitations on liens and subsidiary debt and a maximum consolidated lease adjusted total debt to total capitalization ratio of 0.75 to 1.00) and events of default customary for credit facilities of this type. As of February 26, 2012, we were in compliance with the covenants under the New Revolving Credit Agreement.
The New Revolving Credit Agreement matures on October 3, 2016, and the proceeds may be used for commercial paper back-up, working capital and capital expenditures, the refinancing of certain indebtedness, certain acquisitions and general corporate purposes. The New Revolving Credit Agreement also contains a sub-limit of $150.0 million for the issuance of letters of credit. The borrowings and letters of credit obtained under the New Revolving Credit Agreement may be denominated in U.S. Dollars, Euro, Sterling, Yen, Canadian Dollars and each other currency approved by the New Revolving Credit Lenders. The Company could elect to increase the commitments under the New Revolving Credit Agreement by up to $250.0 million (to an aggregate amount of up to $1.0 billion), subject to the Company obtaining commitments from new and existing lenders for the additional amounts.
Loans under the New Revolving Credit Agreement bear interest at a rate of LIBOR plus a margin determined by reference to a ratings-based pricing grid (Applicable Margin), or the base rate (which is defined as the higher of the BOA prime rate or the Federal Funds rate plus 0.500 percent) plus the Applicable Margin. Assuming a “BBB” equivalent credit rating level, the Applicable Margin under the New Revolving Credit Agreement will be 1.075 percent for LIBOR loans and 0.075 percent for base rate loans. We may also request that loans under the New Revolving Credit Agreement be made at interest rates offered by one or more of the New Revolving Credit Lenders, which may vary from the LIBOR or base rate, for up to $200.0 million of borrowings. The New Revolving Credit Agreement requires that we pay a facility fee on the total amount of such facility (ranging from 0.125 percent to 0.250 percent, based on our credit ratings).
As of February 26, 2012, we had no outstanding balances under the New Revolving Credit Agreement. As of February 26, 2012, $287.7 million of commercial paper and $70.9 million of letters of credit were outstanding, which were backed by this facility. After consideration of borrowings then outstanding and commercial paper and letters of credit backed by the New Revolving Credit Agreement, as of February 26, 2012, we had $391.4 million of credit available under the New Revolving Credit Agreement.
On October 11, 2011, we issued $400.0 million aggregate principal amount of unsecured 4.500 percent senior notes due October 2021 (the New Senior Notes) under a registration statement filed with the SEC on October 6, 2010. Discount and

11

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


issuance costs, which totaled $5.1 million, are being amortized over the term of the New Senior Notes using the straight-line method, the results of which approximate the effective interest method. Interest on the New Senior Notes is payable semi-annually in arrears on April 15 and October 15 of each year, commencing April 15, 2012. We may redeem the New Senior Notes at any time in whole or from time to time in part, at the principal amount plus a make-whole premium. If we experience a change in control triggering event, unless we have previously exercised our right to redeem the New Senior Notes, we may be required to purchase the New Senior Notes from the holders at a purchase price equal to 101 percent of their principal amount plus accrued and unpaid interest.    
The interest rates on our $350.0 million 5.625 percent senior notes due October 2012, $500.0 million 6.200 percent senior notes due October 2017 and $300.0 million 6.800 percent senior notes due October 2037 are subject to adjustment from time to time if the debt rating assigned to such series of notes is downgraded below a certain rating level (or subsequently upgraded). The maximum adjustment is 2.000 percent above the initial interest rate and the interest rate cannot be reduced below the initial interest rate. As of February 26, 2012, no adjustments to these interest rates had been made.
Note 6.Net Earnings per Share
Outstanding stock options and restricted stock granted by us represent the only dilutive effect reflected in diluted weighted average shares outstanding. Options and restricted stock do not impact the numerator of the diluted net earnings per share computation. Restricted stock and options to purchase shares of common stock excluded from the calculation of diluted net earnings per share because the effect would have been anti-dilutive, are as follows: 
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
February 26,
2012
 
February 27,
2011
 
February 26,
2012
 
February 27,
2011
Anti-dilutive restricted stock and options
 
3.1

 
1.4

 
2.7

 
1.2


Note 7.Stockholders’ Equity
Pursuant to the authorization of our Board of Directors to repurchase up to 187.4 million shares of our common stock in accordance with applicable securities laws, we have repurchased a total of 170.5 million shares of our common stock through February 26, 2012. Fiscal 2012 common stock repurchases are as follows:
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
February 26, 2012
 
February 26, 2012
(in millions)
 
Shares
 
Total Cost
 
Shares
 
Total Cost
Common stock repurchased
 
1.8

 
$
77.9

 
7.9

 
$
357.0

Note 8.Retirement Plans
Components of net periodic benefit cost are as follows:
 
 
 
Defined Benefit Plans
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
February 26,
2012
 
February 27,
2011
 
February 26,
2012
 
February 27,
2011
Service cost
 
$
1.4

 
$
1.4

 
$
4.1

 
$
4.4

Interest cost
 
2.2

 
2.4

 
6.7

 
7.2

Expected return on plan assets
 
(4.5
)
 
(4.0
)
 
(13.4
)
 
(12.1
)
Unrecognized prior service cost
 

 
0.1

 

 
0.1

Recognized net actuarial loss
 
1.6

 
1.1

 
4.7

 
3.4

Net periodic benefit cost
 
$
0.7

 
$
1.0

 
$
2.1

 
$
3.0

 

12

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


 
 
Postretirement Benefit Plan
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
February 26,
2012
 
February 27,
2011
 
February 26,
2012
 
February 27,
2011
Service cost
 
$
0.2

 
$
0.2

 
$
0.6

 
$
0.7

Interest cost
 
0.3

 
0.5

 
1.0

 
1.7

Recognized net actuarial loss
 

 
0.4

 

 
1.0

Net periodic benefit cost
 
$
0.5

 
$
1.1

 
$
1.6

 
$
3.4


Note 9.Derivative Instruments and Hedging Activities
We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments as required by Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 815, Derivatives and Hedging, and those utilized as economic hedges. We use financial and commodities derivatives to manage interest rate, compensation and commodities pricing and foreign currency exchange rate risks inherent in our business operations. To the extent our derivatives are effective in offsetting the variability of the hedged cash flows, and otherwise meet the cash flow hedge accounting criteria required by ASC Topic 815, changes in the derivatives’ fair value are not included in current earnings but are included in accumulated other comprehensive income (loss), net of tax. These changes in fair value will be reclassified into earnings at the time of the forecasted transaction. Ineffectiveness measured in the hedging relationship is recorded currently in earnings in the period in which it occurs. To the extent our derivatives are effective in mitigating changes in fair value, and otherwise meet the fair value hedge accounting criteria required by ASC Topic 815, gains and losses in the derivatives’ fair value are included in current earnings, as are the gains and losses of the related hedged item. To the extent the hedge accounting criteria are not met, the derivative contracts are utilized as economic hedges and changes in the fair value of such contracts are recorded currently in earnings in the period in which they occur.
By using these instruments, we expose ourselves, from time to time, to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. We minimize this credit risk by entering into transactions with high quality counterparties. We currently do not have any provisions in our agreements with counterparties that would require either party to hold or post collateral in the event that the market value of the related derivative instrument exceeds a certain limit. As such, the maximum amount of loss due to counterparty credit risk we would incur at February 26, 2012, if counterparties to the derivative instruments failed completely to perform, would approximate the values of derivative instruments currently recognized as assets in our consolidated balance sheet. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates, commodity prices, or the market price of our common stock. We minimize this market risk by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
 
The notional values of derivative contracts designated as hedging instruments and derivative contracts that are not designated as hedging instruments are as follows: 
 
 
Notional Values
(in millions)
 
February 26,
2012
 
May 29,
2011
Derivative contracts designated as hedging instruments
 
 
 
 
Natural gas
 
$

 
$
3.8

Foreign currency
 
6.7

 
20.7

Interest rate locks
 

 
150.0

Interest rate swaps
 
450.0

 
350.0

Equity forwards
 
24.3

 
18.0

Derivative contracts not designated as hedging instruments
 
 
 
 
Natural gas
 
$

 
$
7.7

Other commodities
 
7.1

 
12.7

Equity forwards
 
47.7

 
24.0

We periodically enter into natural gas futures, swaps and option contracts (collectively, natural gas contracts) to reduce

13

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


the risk of variability in cash flows associated with fluctuations in the price of natural gas during the fiscal year. For a certain portion of our natural gas purchases, changes in the price we pay for natural gas is highly correlated with changes in the market price of natural gas. For these natural gas purchases, we designate natural gas contracts as cash flow hedging instruments. For the remaining portion of our natural gas purchases, changes in the price we pay for natural gas are not highly correlated with changes in the market price of natural gas, generally due to the timing of when changes in the market prices are reflected in the price we pay. For these natural gas purchases, we utilize natural gas contracts as economic hedges. We currently have no natural gas contracts outstanding.
We periodically enter into other commodity futures and swaps (typically for soybean oil, milk, diesel fuel and butter) to reduce the risk of fluctuations in the price we pay for these commodities, which are either used directly in our restaurants (e.g., class III milk contracts for cheese and soybean oil for salad dressing) or are components of the cost we pay for items used in our restaurants (i.e., diesel fuel contracts to mitigate risk related to diesel fuel surcharges charged by our distributors). Our other commodity futures and swap contracts currently extend through October 2012.
We periodically enter into foreign currency forward contracts to reduce the risk of fluctuations in exchange rates specifically related to forecasted transactions or payments made in a foreign currency either for commodities and items used directly in our restaurants or for forecasted payments of services. Our foreign currency forward contracts currently extend through June 2012.
We entered into treasury-lock derivative instruments with $300.0 million of notional value to hedge a portion of the risk of changes in the benchmark interest rate prior to the issuance of the New Senior Notes in the second quarter of fiscal 2012, as changes in the benchmark interest rate would cause variability in our forecasted interest payments. These derivative instruments were designated as cash flow hedges. These instruments were settled at the issuance of the New Senior Notes for a cumulative loss of $53.7 million. Of the cumulative loss, $52.6 million was recorded in accumulated other comprehensive income (loss) and will be reclassified into earnings as an adjustment to interest expense on the New Senior Notes or similar debt as incurred.
We entered into forward-starting interest rate swap agreements with $300.0 million of notional value to hedge a portion of the risk of changes in the benchmark interest rate associated with the expected issuance of long-term debt to refinance our $350.0 million 5.625 percent senior notes due October 2012, as changes in the benchmark interest rate will cause variability in our forecasted interest payments. These derivative instruments are designated as cash flow hedges.
We entered into interest rate swap agreements with $150.0 million of notional value to limit the risk of changes in fair value of a portion of the $350.0 million 5.625 percent senior notes due October 2012 attributable to changes in the benchmark interest rate, between inception of the interest rate swap agreements and maturity of the related debt. The swap agreements effectively swap the fixed rate obligations for floating rate obligations, thereby mitigating changes in fair value of the related debt prior to maturity. The swap agreements were designated as fair value hedges of the related debt and met the requirements to be accounted for under the short-cut method, resulting in no ineffectiveness in the hedging relationship. During the quarters ended February 26, 2012 and February 27, 2011, $0.7 million and $0.9 million, respectively, was recorded as a reduction to interest expense related to the net swap settlements. During the nine months ended February 26, 2012 and February 27, 2011, $2.2 million and $2.8 million, respectively, was recorded as a reduction to interest expense related to the net swap settlements.
We enter into equity forward contracts to hedge the risk of changes in future cash flows associated with the unvested, unrecognized Darden stock units. The equity forward contracts will be settled at the end of the vesting periods of their underlying Darden stock units, which range between four and five years. The contracts were initially designated as cash flow hedges to the extent the Darden stock units are unvested and, therefore, unrecognized as a liability in our financial statements. As of February 26, 2012, we were party to equity forward contracts that were indexed to 1.1 million shares of our common stock, at varying forward rates between $27.57 per share and $45.66 per share, extending through August 2016. The forward contracts can only be net settled in cash. As the Darden stock units vest, we will de-designate that portion of the equity forward contract that no longer qualifies for hedge accounting and changes in fair value associated with that portion of the equity forward contract will be recognized in current earnings. We periodically incur interest on the notional value of the contracts and receive dividends on the underlying shares. These amounts are recognized currently in earnings as they are incurred.
We entered into equity forward contracts to hedge the risk of changes in future cash flows associated with recognized, cash-settled performance stock units and employee-directed investments in Darden stock within the non-qualified deferred compensation plan. The equity forward contracts are indexed to 0.7 million shares of our common stock at forward rates between $23.41 and $50.19 per share, can only be net settled in cash and expire between fiscal 2012 and 2016. We did not elect hedge accounting with the expectation that changes in the fair value of the equity forward contracts would offset changes in the fair value of the performance stock units and Darden stock investments in the non-qualified deferred compensation plan within

14

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


selling, general and administrative expenses in our consolidated statements of earnings.
The fair value of our derivative contracts designated as hedging instruments and derivative contracts that are not designated as hedging instruments are as follows: 
  
 
Balance
Sheet
Location
 
Derivative Assets
 
Derivative Liabilities
(in millions)
 
February 26,
2012
 
May 29,
2011
 
February 26,
2012
 
May 29,
2011
Derivative contracts designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
Commodity contracts
 
(1)
 
$

 
$
0.1

 
$

 
$

Equity forwards
 
(1)
 

 
0.4

 

 

Interest rate related
 
(1)
 
1.8

 
3.6

 
(36.6
)
 
(23.2
)
Foreign currency forwards
 
(1)
 
0.2

 
0.6

 

 

 
 
 
 
$
2.0

 
$
4.7

 
$
(36.6
)
 
$
(23.2
)
Derivative contracts not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
Commodity contracts
 
(1)
 
$
0.5

 
$
0.6

 
$

 
$

Equity forwards
 
(1)
 

 
0.5

 
(0.1
)
 

 
 
 
 
$
0.5

 
$
1.1

 
$
(0.1
)
 
$

Total derivative contracts
 
$
2.5

 
$
5.8

 
$
(36.7
)
 
$
(23.2
)
 
(1)
Derivative assets and liabilities are included in receivables, net, prepaid expenses and other current assets and other current liabilities, as applicable, on our consolidated balance sheets.

The effects of derivative instruments in cash flow hedging relationships on the consolidated statements of earnings are as follows:
 
(in millions)
 
Amount of Gain (Loss)
Recognized in AOCI
(effective portion)
 
Location of
Gain (Loss)
Reclassified
from AOCI to
Earnings
 
Amount of Gain (Loss)
Reclassified from AOCI to
Earnings (effective portion)
 
Location of
Gain (Loss)
Recognized in
Earnings
(ineffective
portion)
 
(1) Amount of Gain (Loss)
Recognized in Earnings
(ineffective portion)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
Type of Derivative
 
February 26,
2012
 
February 27,
2011
 
 
 
February 26,
2012
 
February 27,
2011
 
 
 
February 26,
2012
 
February 27,
2011
Commodity
 
$
(0.1
)
 
$
(0.3
)
 
(2)
 
$
(1.1
)
 
$

 
(2)
 
$

 
$

Equity
 
2.4

 
(1.9
)
 
(3)
 

 

 
(3)
 
0.2

 
0.1

Interest rate
 
(3.5
)
 
15.1

 
Interest, net
 
(1.1
)
 
0.2

 
Interest, net
 

 
(0.5
)
Foreign currency
 
0.6

 
(0.3
)
 
(4)
 
0.2

 
0.6

 
(4)
 

 

 
 
$
(0.6
)
 
$
12.6

 
 
 
$
(2.0
)
 
$
0.8

 
 
 
$
0.2

 
$
(0.4
)
 
 

15

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


(in millions)
 
Amount of Gain (Loss)
Recognized in AOCI
(effective portion)
 
Location of
Gain (Loss)
Reclassified
from AOCI to
Earnings
 
Amount of Gain (Loss)
Reclassified from AOCI to
Earnings (effective portion)
 
Location of
Gain (Loss)
Recognized in
Earnings
(ineffective
portion)
 
(1) Amount of Gain (Loss)
Recognized in Earnings
(ineffective portion)
 
 
Nine Months Ended
 
 
 
Nine Months Ended
 
 
 
Nine Months Ended
Type of Derivative
 
February 26,
2012
 
February 27,
2011
 
 
 
February 26,
2012
 
February 27,
2011
 
 
 
February 26,
2012
 
February 27,
2011
Commodity
 
$
(1.7
)
 
$
(0.3
)
 
(2)
 
$
(1.7
)
 
$
(0.9
)
 
(2)
 
$

 
$

Equity
 
(2.0
)
 
1.6

 
(3)
 

 

 
(3)
 
0.5

 
0.2

Interest rate
 
(67.0
)
 
3.8

 
Interest, net
 
(1.8
)
 
0.5

 
Interest, net
 
(0.7
)
 
(0.8
)
Foreign currency
 
0.4

 
(0.3
)
 
(4)
 
0.7

 
0.7

 
(4)
 

 

 
 
$
(70.3
)
 
$
4.8

 
 
 
$
(2.8
)
 
$
0.3

 
 
 
$
(0.2
)
 
$
(0.6
)



(1)
Generally, all of our derivative instruments designated as cash flow hedges have some level of ineffectiveness, which is recognized currently in earnings. However, as these amounts are generally nominal and our consolidated financial statements are presented “in millions,” these amounts will generally appear as zero in this tabular presentation.
(2)
Location of the gain (loss) reclassified from AOCI to earnings as well as the gain (loss) recognized in earnings for the ineffective portion of the hedge is food and beverage costs and restaurant expenses, which are components of cost of sales.
(3)
Location of the gain (loss) reclassified from AOCI to earnings as well as the gain (loss) recognized in earnings for the ineffective portion of the hedge is restaurant labor expenses, which is a component of cost of sales, and selling, general and administrative expenses.
(4)
Location of the gain (loss) reclassified from AOCI to earnings as well as the gain (loss) recognized in earnings for the ineffective portion of the hedge is food and beverage costs, which is a component of cost of sales, and selling, general and administrative expenses.
 
The effects of derivative instruments in fair value hedging relationships on the consolidated statements of earnings are as follows:
(in millions)
 
Amount of Gain (Loss)
Recognized in Earnings on
Derivatives
 
Location of
Gain (Loss)
Recognized in
Earnings on
Derivatives
 
Hedged Item in
Fair Value Hedge
Relationship
 
Amount of Gain (Loss)
Recognized in Earnings on
Related Hedged Item
 
Location of
Gain (Loss)
Recognized in
Earnings on
Related
Hedged Item
 
 
Three Months Ended
 
 
 
 
 
Three Months Ended
 
 
 
 
February 26,
2012
 
February 27,
2011
 
 
 
 
 
February 26,
2012
 
February 27,
2011
 
 
Interest rate
 
$
(0.3
)
 
$
(0.5
)
 
Interest, net
 
Fixed-rate debt
 
$
0.3

 
$
0.5

 
Interest, net


(in millions)
 
Amount of Gain (Loss)
Recognized in Earnings on
Derivatives
 
Location of
Gain (Loss)
Recognized in
Earnings on
Derivatives
 
Hedged Item in
Fair Value Hedge
Relationship
 
Amount of Gain (Loss)
Recognized in Earnings on
Related Hedged Item
 
Location of
Gain (Loss)
Recognized in
Earnings on
Related
Hedged Item
 
 
Nine Months Ended
 
 
 
 
 
Nine Months Ended
 
 
 
 
February 26,
2012
 
February 27,
2011
 
 
 
 
 
February 26,
2012
 
February 27,
2011
 
 
Interest rate
 
$
(1.9
)
 
$
0.4

 
Interest, net
 
Fixed-rate debt
 
$
1.9

 
$
(0.4
)
 
Interest, net

16

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


The effects of derivatives not designated as hedging instruments on the consolidated statements of earnings are as follows:
  
 
Location of Gain (Loss)
Recognized
in Earnings on
Derivatives
 
Amount of Gain (Loss) Recognized in Earnings
 
 
Three Months Ended
 
Nine Months Ended
 
 
February 26, 2012
 
February 27, 2011
 
February 26, 2012
 
February 27, 2011
(in millions)
 
 
 
 
Commodity contracts
 
(1)
 
$
(2.6
)
 
$

 
$
(7.3
)
 
$

Equity forwards
 
(2)
 
1.5

 
(0.1
)
 
0.7

 
1.7

Equity forwards
 
Selling, General and Administrative
 
4.5

 
(0.3
)
 
1.9

 
1.7

 
 
 
 
$
3.4

 
$
(0.4
)
 
$
(4.7
)
 
$
3.4

 
(1)
Location of the gain (loss) recognized in earnings is food and beverage costs and restaurant expenses, which are components of cost of sales.
(2)
Location of the gain (loss) recognized in earnings is restaurant labor expenses, which is a component of cost of sales.
Based on the fair value of our derivative instruments designated as cash flow hedges as of February 26, 2012, we expect to reclassify $5.3 million of net losses on derivative instruments from accumulated other comprehensive income (loss) to earnings during the next twelve months based on the timing of our forecasted commodity purchases and maturity of equity forward and interest rate related instruments. However, the amounts ultimately realized in earnings will be dependent on the fair value of the contracts on the settlement dates.
Note 10. Fair Value Measurements

The fair values of cash equivalents, accounts receivable, accounts payable and short-term debt approximate their carrying amounts due to their short duration.
The following table summarizes the fair values of financial instruments measured at fair value on a recurring basis as reflected in our unaudited consolidated balance sheet as of February 26, 2012 and May 29, 2011:
 
Items Measured at Fair Value at February 26, 2012
(in millions)
 
 
Fair value
of assets
(liabilities)
 
Quoted prices
in active
market for
identical assets
(liabilities)
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Fixed-income securities:
 
 
 
 
 
 
 
 
 
Corporate bonds
(1
)
 
$
14.6

 
$

 
$
14.6

 
$

U.S. Treasury securities
(2
)
 
13.2

 
13.2

 

 

Mortgage-backed securities
(1
)
 
10.0

 

 
10.0

 

Derivatives:
 
 
 
 
 
 
 
 
 
Commodities futures, swaps & options
(3
)
 
0.5

 

 
0.5

 

Equity forwards
(4
)
 
(0.1
)
 

 
(0.1
)
 

Interest rate swaps
(5
)
 
(34.8
)
 

 
(34.8
)
 

Foreign currency forwards
(6
)
 
0.2

 

 
0.2

 

Total
 
 
$
3.6

 
$
13.2

 
$
(9.6
)
 
$

 


17

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


Items Measured at Fair Value at May 29, 2011
(in millions)
 
 
Fair value
of assets
(liabilities)
 
Quoted prices
in active
market for
identical assets
(liabilities)
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Fixed-income securities:
 
 
 
 
 
 
 
 
 
Corporate bonds
(1
)
 
$
16.6

 
$

 
$
16.6

 
$

U.S. Treasury securities
(2
)
 
10.6

 
10.6

 

 

Mortgage-backed securities
(1
)
 
4.9

 

 
4.9

 

Derivatives:
 
 

 

 

 

Commodities futures, swaps & options
(3
)
 
0.7

 

 
0.7

 

Equity forwards
(4
)
 
0.9

 

 
0.9

 

Interest rate locks & swaps
(5
)
 
(19.6
)
 

 
(19.6
)
 

Foreign currency forwards
(6
)
 
0.6

 

 
0.6

 

Total
 
 
$
14.7

 
$
10.6

 
$
4.1

 
$

(1)
The fair value of these securities is based on closing market prices of the investments when applicable, or, alternatively, valuations utilizing market data and other observable inputs, inclusive of the risk of nonperformance.
(2)
The fair value of our U.S. Treasury securities is based on closing market prices.
(3)
The fair value of our commodities futures, swaps and options classified as Level 2 is based on closing market prices of the contracts, inclusive of the risk of nonperformance.
(4)
The fair value of our equity forwards is based on closing market values of Darden stock, inclusive of the risk of nonperformance.
(5)
The fair value of our interest rate lock and swap agreements is based on current and expected market interest rates, inclusive of the risk of nonperformance.
(6)
The fair value of our foreign currency forward contracts is based on closing forward exchange market prices, inclusive of the risk of nonperformance.
The carrying value and fair value of long-term debt, including the amounts included in current liabilities, as of February 26, 2012, was $1.80 billion and $2.04 billion, respectively. The carrying value and fair value of long-term debt as of May 29, 2011, was $1.41 billion and $1.56 billion, respectively. The fair value of long-term debt is determined based on market prices or, if market prices are not available, the present value of the underlying cash flows discounted at our incremental borrowing rates.
The following table summarizes the fair values of non-financial assets measured at fair value on a non-recurring basis as of February 26, 2012:
Items Measured at Fair Value
(in millions)
 
 
Fair Value of Assets
 
Quoted prices in
active market for
identical assets
(liabilities)
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Long-lived assets held for disposal
(1
)
 
$
0.8

 
$

 
$

 
$
0.8

Long-lived assets held and used
(2
)
 

 

 

 

Total
 
 
$
0.8

 
$

 
$

 
$
0.8

(1)
In accordance with the provisions of ASC Topic 360, Property, Plant and Equipment, during fiscal 2012, long-lived assets held for disposal with a carrying amount of $0.9 million were written down to their fair value of $0.8 million, based on a review of comparable assets, resulting in an impairment charge of $0.1 million, which was included in losses from discontinued operations.
(2)
In accordance with the provisions of ASC Topic 360, Property, Plant and Equipment, during fiscal 2012, long-lived assets held and used with a carrying amount of $0.3 million were written down to their fair value of $0.0 million, due to fire loss, resulting in an impairment charge of $0.3 million, which was included in earnings from continuing operations.
The following table summarizes the fair values of non-financial assets measured at fair value on a non-recurring basis as of May 29, 2011:

18

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


 
Items Measured at Fair Value
(in millions)
 
 
Fair value
of assets
 
Quoted prices in
active market for
identical assets
(liabilities)
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Long-lived assets held for disposal
(1
)
 
$
4.4

 
$

 
$

 
$
4.4

Long-lived assets held and used
(2
)
 
0.7

 

 

 
0.7

Total
 
 
$
5.1

 
$

 
$

 
$
5.1

 
(1)
In accordance with the provisions of ASC Topic 360, Property, Plant and Equipment, during fiscal 2011, long-lived assets held for disposal with a carrying amount of $7.0 million were written down to their fair value of $4.4 million, based on a review of comparable assets, resulting in an impairment charge of $2.6 million, of which $1.9 million was included in earnings from continuing operations and $0.7 million was included in losses from discontinued operations.
(2)
In accordance with the provisions of ASC Topic 360, Property, Plant and Equipment, during fiscal 2011, long-lived assets held and used with a carrying amount of $2.8 million were written down to their fair value of $0.7 million, based on a review of comparable assets, resulting in an impairment charge of $2.1 million, which was included in earnings from continuing operations.
Note 11. Commitments and Contingencies
As collateral for performance on contracts and as credit guarantees to banks and insurers, we are contingently liable for guarantees of subsidiary obligations under standby letters of credit. As of February 26, 2012 and May 29, 2011, we had $99.2 million and $96.4 million, respectively, of standby letters of credit related to workers’ compensation and general liabilities accrued in our consolidated financial statements. As of February 26, 2012 and May 29, 2011, we had $19.6 million and $16.8 million, respectively, of standby letters of credit related to contractual operating lease obligations and other payments. All standby letters of credit are renewable annually.
As of February 26, 2012 and May 29, 2011, we had $5.7 million and $7.4 million, respectively, of guarantees associated with leased properties that have been assigned to third parties. These amounts represent the maximum potential amount of future payments under the guarantees. The fair value of these potential payments discounted at our pre-tax cost of capital as of February 26, 2012 and May 29, 2011, amounted to $4.3 million and $5.4 million, respectively. We did not accrue for the guarantees, as the likelihood of the third parties defaulting on the assignment agreements was deemed to be less than probable. In the event of default by a third party, the indemnity and default clauses in our assignment agreements govern our ability to recover from and pursue the third party for damages incurred as a result of its default. We do not hold any third-party assets as collateral related to these assignment agreements, except to the extent that the assignment allows us to repossess the building and personal property. These guarantees expire over their respective lease terms, which range from fiscal 2013 through fiscal 2021.
We are subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of our business. A number of these lawsuits, proceedings and claims may exist at any given time. These matters typically involve claims from guests, employees and others related to operational issues common to the restaurant industry, and can also involve infringement of, or challenges to, our trademarks. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, we believe that the final disposition of the lawsuits, proceedings and claims in which we are currently involved, either individually or in the aggregate, will not have a material adverse effect on our financial position, results of operations or liquidity. 
Note 12. Application of New Accounting Standards
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. Many of the amendments in this update change the wording used in the existing guidance to better align U.S. generally accepted accounting principles with International Financial Reporting Standards and to clarify the FASB's intent on various aspects of the fair value guidance. This update also requires increased disclosure of quantitative information about unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. This update is effective for us in our first quarter of fiscal 2013 and will be applied prospectively. Other than requiring additional disclosures, adoption of this new guidance will not have a significant impact on our consolidated financial statements.

19

DARDEN RESTAURANTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 


In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income, which requires companies to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This update eliminates the option to present the components of other comprehensive income as part of the statement of equity. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05, to defer the effective date of the specific requirement to present items that are reclassified out of accumulated other comprehensive income to net income alongside their respective components of net income and other comprehensive income. All other provisions of this update are effective for us in our first quarter of fiscal 2013 and will be applied retrospectively. We do not believe adoption of this new guidance will have a significant impact on our consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350), Testing Goodwill for Impairment, which permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying value before applying the two-step goodwill impairment model that is currently in place. If it is determined through the qualitative assessment that a reporting unit's fair value is more likely than not greater than its carrying value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. This update is effective for annual and interim goodwill impairment tests performed in fiscal years beginning after December 15, 2011, which will require us to adopt these provisions in fiscal 2013; however, early adoption is permitted. We do not believe adoption of this new guidance will have a significant impact on our consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities, which requires companies to disclose information about financial instruments that have been offset and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Companies will be required to provide both net (offset amounts) and gross information in the notes to the financial statements for relevant assets and liabilities that are offset. This update is effective for us in our first quarter of fiscal 2014 and will be applied retrospectively. We do not believe adoption of this new guidance will have a significant impact on our consolidated financial statements.
Note 13. Subsequent Events
On March 22, 2012, the Board of Directors declared a cash dividend of $0.43 per share to be paid May 1, 2012 to all shareholders of record as of the close of business on April 10, 2012.


20


Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
The discussion and analysis below for the Company, which contains forward-looking statements, should be read in conjunction with the unaudited financial statements, the notes to such financial statements and the “Forward-Looking Statements” included elsewhere in this Form 10-Q.
The following table sets forth selected operating data as a percent of sales for the periods indicated. All information is derived from the unaudited consolidated statements of earnings for the quarters and nine months ended February 26, 2012 and February 27, 2011.
 
 
Three Months Ended
 
Nine Months Ended
 
February 26, 2012
 
February 27, 2011
 
February 26, 2012
 
February 27, 2011
Sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Food and beverage
30.6

 
28.9

 
30.8

 
28.6

Restaurant labor
30.4

 
31.4

 
31.4

 
32.2

Restaurant expenses
14.3

 
14.5

 
15.2

 
15.2

Total cost of sales, excluding restaurant depreciation and amortization of 3.9%, 3.8%, 4.1% and 4.0%, respectively
75.3
 %
 
74.8