Exhibit 13
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This discussion and analysis below for Darden Restaurants, Inc. should be read
in conjunction with our consolidated financial statements and related notes
found elsewhere in this report.
For financial reporting, we operate on a 52/53 week fiscal year ending on the
last Sunday in May. Our 2004 fiscal year, which ended on May 30, 2004, had 53
weeks. Our 2003 fiscal year, which ended on May 25, 2003, and our 2002 fiscal
year, which ended on May 26, 2002, each had 52 weeks. We have included in this
discussion certain financial information for fiscal 2004 on a 52-week basis in
order to assist investors in making comparisons to our prior fiscal years.
OVERVIEW OF OPERATIONS
Our business operates in the casual dining segment of the restaurant industry,
primarily in the United States. At May 30, 2004, we operated 1,325 Red Lobster,
Olive Garden, Bahama Breeze, Smokey Bones Barbeque & Grill, and Seasons 52
restaurants in the United States and Canada and licensed 38 Red Lobster
restaurants in Japan. We own and operate all of our restaurants in the United
States and Canada, with no franchising.
Our sales were $5.00 billion in fiscal 2004 and $4.65 billion in fiscal 2003, a
7.5 percent increase. On a 52-week basis, after adjusting for the $90 million of
sales contributed by the additional 53rd operating week in fiscal 2004, total
sales would have been $4.91 billion for fiscal 2004, a 5.5 percent increase from
fiscal 2003. Net earnings for fiscal 2004 were $231 million ($1.36 per diluted
share) compared with net earnings for fiscal 2003 of $232 million ($1.31 per
diluted share). Net earnings for fiscal 2004 decreased 0.3 percent and diluted
net earnings per share increased 3.8 percent compared to fiscal 2003. Although
Red Lobster's string of 23 consecutive quarters of U.S. same-restaurant sales
gains ended during fiscal 2004, Red Lobster has made progress in some important
areas. Red Lobster improved its operating efficiency during fiscal 2004 through
improvements in labor management and other cost controls, as well as
implementing a less-disruptive promotional strategy in the second half of fiscal
2004, which resulted in higher operating profit than in fiscal 2003. Results
from guest satisfaction surveys also improved as the fiscal year progressed. Red
Lobster retained a new advertising agency in fiscal 2004 and is in the process
of developing a marketing plan designed to achieve more sustainable benefits
than have been obtained in prior years. Red Lobster also is developing new
entree offerings in the $10-$15 price range to strengthen the value offered to
its guests. Olive Garden's sales gains in fiscal 2004, combined with lower food
and beverage costs, restaurant expenses, and selling, general, and
administrative expenses as a percent of sales, more than offset increased
restaurant labor expenses as a percent of sales. This resulted in a double-digit
increase in operating profit for Olive Garden during fiscal 2004 along with
record annual operating profit and return on sales.
In fiscal 2005, we expect to increase our number of restaurants by approximately
50 to 60 restaurants. We expect combined same-restaurant sales growth in fiscal
2005 of between one percent and three percent for Red Lobster and Olive Garden.
We believe we can achieve diluted net earnings per share growth in the range of
8 percent to 12 percent for fiscal 2005. In fiscal 2005, we also expect Bahama
Breeze to be accretive to earnings, and Smokey Bones to remain dilutive to
earnings. However, we expect Smokey Bones to be accretive to earnings in the
second half of fiscal 2005. As with same-restaurant sales growth, there can
always be some quarter-to-quarter variability in operating results, where
specific factors put us above or below the expected range of diluted net
earnings per share growth. We believe our strong balance sheet and cash flows
will be important factors in helping us reach our goals.
Our mission is to be the best in casual dining, now and for generations. To
achieve this goal, we focus on four strategic imperatives: leadership
excellence, brand management excellence, service and hospitality excellence, and
culinary and beverage excellence.
From a financial perspective, we seek to increase sales and profits. To evaluate
our operations and assess our financial performance, we use the following two
key factors:
o Same-restaurant sales - a year-over-year comparison of each period's
sales volumes for restaurants that are open more than 16 months; and
o Operating margins - restaurant sales less restaurant-level cost of
sales (food and beverage costs, restaurant labor, and other restaurant
expenses).
Increasing same-restaurant sales can increase operating margins, since these
incremental sales provide better leverage of our fixed costs. Same-restaurant
sales increases can be generated by increases in guest traffic, increases in the
average guest check, or a combination of the two. The average guest check can be
impacted by menu price changes and by the mix of menu items sold. For each
concept, we gather sales data daily and regularly analyze the guest traffic
counts and the mix of menu items sold to assist in developing menu pricing,
product offerings, and promotional strategies. We view guest traffic counts as
an indication of the long-term health of a concept, while increases in average
check and menu mix may contribute more significantly to near-term profitability.
We
1
continually focus on balancing our pricing and product offerings with other
initiatives to generate sustainable growth in same-restaurant sales.
Incremental same-restaurant sales increases make a significant contribution to
our profitability. Many restaurant-level expenses are relatively fixed in nature
and do not vary with sales volumes. Therefore, same-restaurant sales increases
can improve our profitability. We define same-restaurants as restaurants that
have been open at least 16 months. New restaurants experience an adjustment
period before sales levels and operating margins normalize, and sales at newly
opened restaurants generally do not make a significant contribution to
profitability in their initial months of operation. Our sales and expenses can
be impacted significantly by the number and timing of the opening of new
restaurants, and the closing, relocation, and remodeling of existing
restaurants. Pre-opening expenses each period reflect the costs associated with
opening new restaurants in current and future periods.
There are significant risks and challenges that could impact our operations and
ability to increase sales and earnings. The casual dining restaurant industry is
highly competitive and sensitive to economic turns, trends in lifestyles and
fluctuating costs. Operating margins for our concepts are susceptible to changes
in the price of commodities, including seafood, beef, pork, chicken, cheese,
produce, natural gas, and other energy supplies. Other risks and uncertainties
include the price and availability of labor, insurance and media; possible
unfavorable publicity relating to food safety or other concerns; government
regulation and litigation; and factors that could impact our growth plans,
including the availability of suitable restaurant locations, construction cost
increases, construction delays, and other factors.
RESULTS OF OPERATIONS FOR FISCAL 2004, 2003 and 2002
The following table sets forth selected operating data as a percentage of sales
for the 53-week period ended May 30, 2004 and the 52-week periods ended May 25,
2003 and May 26, 2002. All information is derived from the consolidated
statements of earnings for the periods indicated.
Fiscal Years
------------------------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------------------------------------------------------------------------------------------
Sales......................................................... 100.0% 100.0% 100.0%
Costs and expenses:
Cost of sales:
Food and beverage........................................ 30.5 31.1 31.7
Restaurant labor......................................... 32.0 31.9 31.5
Restaurant expenses...................................... 15.4 15.1 14.4
----- ----- -----
Total cost of sales, excluding restaurant depreciation
and amortization of 3.9%, 3.8%, and 3.6%,
respectively........................................ 77.9% 78.1% 77.6%
Selling, general, and administrative....................... 9.4 9.3 9.5
Depreciation and amortization.............................. 4.2 4.1 3.8
Interest, net.............................................. 0.9 0.9 0.9
Asset impairment and restructuring charges (credits), net.. 0.8 0.1 (0.1)
----- ----- -----
Total costs and expenses......................... 93.2% 92.5% 91.7%
----- ----- -----
Earnings before income taxes.................................. 6.8 7.5 8.3
Income taxes.................................................. 2.2 2.5 2.9
----- ----- -----
Net earnings.................................................. 4.6% 5.0% 5.4%
===== ===== =====
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SALES
Sales were $5.00 billion in fiscal 2004, $4.65 billion in fiscal 2003, and $4.37
billion in fiscal 2002. The 7.5% increase in company-wide sales for fiscal 2004
was primarily due to a net increase of 54 company-owned restaurants since fiscal
2003, same-restaurant sales increases at Olive Garden, and the additional
operating week in fiscal 2004. These sales increases were partially offset by
decreased same-restaurant sales at Red Lobster. After adjusting for $90 million
of sales contributed by the additional operating week, total sales would have
been $4.91 billion for fiscal 2004 on a 52-week basis, a 5.5 percent increase
from fiscal 2003.
Red Lobster sales of $2.44 billion were 0.1 percent above last year. U.S.
same-restaurant sales for Red Lobster decreased 3.5 percent due to a 6.5 percent
decrease in same-restaurant guest counts, offset partially by a 3.0 percent
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increase in average check. Average annual sales per restaurant for Red Lobster
were $3.6 million in fiscal 2004 (on a 52-week basis).
Olive Garden sales of $2.21 billion were 11.1 percent above last year. U.S.
same-restaurant sales for Olive Garden increased 4.6 percent due to a 3.0
percent increase in average check and a 1.6 percent increase in same-restaurant
guest counts. Average annual sales per restaurant for Olive Garden were $4.1
million in fiscal 2004 (on a 52-week basis). Olive Garden has enjoyed 39
consecutive quarters of U.S. same-restaurant sales increases.
Bahama Breeze sales of $176 million were 28 percent above last year. Bahama
Breeze opened four new restaurants during fiscal 2004, including its new
prototype restaurant in Pittsburgh, PA. Bahama Breeze also closed six
restaurants during the fourth quarter of fiscal 2004 as a result of a
comprehensive analysis performed during the fourth quarter of fiscal 2004 that
examined restaurants not meeting our minimum return-on-investment thresholds and
certain other operating performance criteria. Average annual sales per
restaurant (excluding the six closed restaurants) were $5.2 million (on a
52-week basis). Smokey Bones sales of $174 million were 87 percent above last
year. Average annual sales per restaurant were $3.2 million (on a 52-week
basis). Smokey Bones opened 30 new restaurants during fiscal 2004.
The 6.6 percent increase in company-wide sales for fiscal 2003 versus fiscal
2002 was primarily due to same-restaurant sales increases in the U.S. and a net
increase of 60 company-owned restaurants since fiscal 2002. Red Lobster sales of
$2.43 billion were 4.1 percent above fiscal 2002. U.S. same-restaurant sales for
Red Lobster increased 2.7 percent due to a 3.1 percent increase in average
check, partially offset by a 0.4 percent decrease in same-restaurant guest
counts. Average annual sales per restaurant for Red Lobster were $3.7 million in
fiscal 2003. Olive Garden sales of $1.99 billion were 6.8 percent above fiscal
2002. U.S. same-restaurant sales for Olive Garden increased 2.2 percent due to a
3.7 percent increase in average check and a 1.5 percent decrease in
same-restaurant guest counts. Average annual sales per restaurant for Olive
Garden were $3.9 million in fiscal 2003. Bahama Breeze opened five new
restaurants during fiscal 2003 and generated sales that exceeded $137 million.
Smokey Bones opened 20 new restaurants during fiscal 2003 and generated sales of
$93 million.
COSTS AND EXPENSES
Total costs and expenses were $4.66 billion in fiscal 2004, $4.31 billion in
fiscal 2003, and $4.00 billion in fiscal 2002. Total costs and expenses in
fiscal 2004 were 93.2 percent of sales, an increase from 92.5 percent of sales
in fiscal 2003. The following analysis of the components of total costs and
expenses is presented as a percent of sales.
Food and beverage costs increased $78 million, or 5.4 percent, from $1.45
billion to $1.53 billion in fiscal 2004 compared to fiscal 2003. Food and
beverage costs increased $65 million, or 4.7 percent, from $1.38 billion to
$1.45 billion in fiscal 2003 compared to fiscal 2002. As a percent of sales,
food and beverage costs decreased from the prior year in fiscal 2004 and fiscal
2003 primarily as a result of pricing changes, and favorable changes in
promotional and menu mix of sales, which was partially offset by higher seafood
costs and by crab usage and additional plate accompaniments at Red Lobster
during its crab promotion in the first quarter of fiscal 2004. Other commodity
costs, such as chicken and shrimp, decreased modestly.
Restaurant labor increased $116 million, or 7.8 percent, from $1.49 billion to
$1.60 billion in fiscal 2004 compared to fiscal 2003. Restaurant labor increased
$112 million, or 8.1 percent, from $1.37 billion to $1.49 billion in fiscal 2003
compared to fiscal 2002. As a percent of sales, restaurant labor increased in
fiscal 2004 primarily as a result of a modest increase in wage rates at Red
Lobster and Olive Garden, and higher manager bonuses at Olive Garden as a result
of their increased operating performance in fiscal 2004. These factors were only
partially offset by the favorable impact of higher sales volumes and lower
health insurance costs as a result of fewer claims. As a percent of sales,
restaurant labor increased in fiscal 2003 primarily as a result of a modest
increase in wage rates, higher promotional staffing levels, and increased sales
volatility, which made it more difficult to predict staffing needs. These
factors were only partially offset by the favorable impact of higher sales
volumes.
Restaurant expenses (which include lease, property tax, credit card, utility,
workers' compensation, insurance, new restaurant pre-opening, and other
restaurant-level operating expenses) increased $64 million, or 9.1 percent, from
$704 million to $768 million in fiscal 2004 compared to fiscal 2003. Restaurant
expenses increased $75 million, or 11.9 percent, from $629 million to $704
million in fiscal 2003 compared to fiscal 2002. As a percent of sales,
restaurant expenses increased in fiscal 2004 and fiscal 2003 primarily due to
increased utility, workers' compensation, insurance, and new restaurant
pre-opening costs. These cost increases were only partially offset by the
favorable impact of higher sales volumes.
Selling, general, and administrative expenses increased $40 million, or 9.4
percent, from $432 million to $472 million in fiscal 2004 compared to fiscal
2003. Selling, general, and administrative expenses increased $15 million, or
3.5 percent, from $417 million to $432 million in fiscal 2003 compared to fiscal
2002. As a percent of sales, selling, general, and administrative expenses
increased in fiscal 2004 primarily due to increased employee benefit
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costs, an increase in the amount contributed to the Darden Restaurants, Inc.
Foundation, and an increase in litigation related costs, which were only
partially offset by the favorable impact of higher sales volumes. As a percent
of sales, selling, general, and administrative expenses in fiscal 2003 were less
than fiscal 2002 primarily as a result of decreased bonus costs and the
favorable impact of higher sales volumes, which were partially offset by
increased marketing expense incurred in response to the challenging economic and
competitive environment.
Depreciation and amortization expense increased $19 million, or 9.8 percent,
from $191 million to $210 million in fiscal 2004 compared to fiscal 2003.
Depreciation and amortization expense increased $25 million, or 15.3 percent,
from $166 million to $191 million in fiscal 2003 compared to fiscal 2002. As a
percent of sales, depreciation and amortization increased in fiscal 2004 and
2003 primarily as a result of new restaurant and remodel activities, which were
only partially offset by the favorable impact of higher sales volumes.
Net interest expense increased $1 million, or 2.5 percent, from $43 million to
$44 million in fiscal 2004 compared to fiscal 2003. Net interest expense
increased $6 million, or 16.4 percent, from $37 million to $43 million in fiscal
2003 compared to fiscal 2002. As a percent of sales, net interest expense in
fiscal 2004 was comparable to fiscal 2003, reflecting lower interest income in
fiscal 2004, offset by the favorable impact of higher sales volumes. As a
percent of sales, net interest expense in fiscal 2003 was comparable to fiscal
2002 primarily because increased interest expense associated with higher average
debt levels in fiscal 2003 was offset by the favorable impact of higher sales
volumes.
After a comprehensive analysis performed during the fourth quarter of fiscal
2004 that examined restaurants not meeting our minimum return-on-investment
thresholds and other operating performance criteria, we recorded a $36.5 million
pre-tax ($22.4 million after-tax) charge for long-lived asset impairments
associated with the closing of six Bahama Breeze restaurants and the write-down
of the carrying value of four other Bahama Breeze restaurants, one Olive Garden
restaurant, and one Red Lobster restaurant, which continued to operate. We also
recorded a $1.1 million pre-tax ($0.7 million after-tax) restructuring charge
primarily related to severance payments made to certain restaurant employees and
exit costs associated with the closing of the six Bahama Breeze restaurants.
During fiscal 2004, certain changes were made at Bahama Breeze to improve its
sales, financial performance, and overall long-term potential, including the
addition of lunch at most restaurants and introduction of a new dinner menu. The
decision to close certain Bahama Breeze restaurants and write down the carrying
value of others was based on our on-going review of each individual restaurant's
performance against our expectations and their ability to successfully implement
these changes. Based on our review of the other 28 Bahama Breeze restaurants, we
believe their locations and ability to execute these and future initiatives will
minimize the likelihood that additional impairment charges will be required. The
write-down of the carrying value of one Olive Garden restaurant and one Red
Lobster restaurant was a result of less-than-optimal locations. We will continue
to evaluate all of our locations to minimize the risk of future asset impairment
charges. In addition to the fiscal 2004 fourth quarter action, we recognized
asset impairment charges in the amount of $5.7 million and $4.9 million in
fiscal 2004 and 2003, respectively, related to the relocation and rebuilding of
certain restaurants. Asset impairment credits related to the sale of assets that
were previously impaired amounted to $1.4 million and $0.6 million in fiscal
2004 and 2003, respectively. Pre-tax restructuring credits of $0.4 million and
$2.6 million were recorded in fiscal 2003 and 2002, respectively. The credits
resulted from lower than projected costs of lease terminations in connection
with our fiscal 1997 restructuring. All fiscal 1997 restructuring actions were
completed as of May 25, 2003.
INCOME TAXES
The effective income tax rates for fiscal 2004, 2003, and 2002 were 31.9
percent, 33.2 percent, and 34.6 percent, respectively. The rate decrease in
fiscal 2004 and fiscal 2003 was primarily a result of favorable resolutions of
prior year tax matters and an increase in FICA tax credits for employee-reported
tips.
NET EARNINGS AND NET EARNINGS PER SHARE
Net earnings for fiscal 2004 were $231 million ($1.36 per diluted share)
compared with net earnings for fiscal 2003 of $232 million ($1.31 per diluted
share) and net earnings for fiscal 2002 of $238 million ($1.30 per diluted
share).
Net earnings for fiscal 2004 decreased 0.3 percent and diluted net earnings per
share increased 3.8 percent compared to fiscal 2003. The decrease in net
earnings was primarily due to the $38 million pre-tax ($23 million after-tax)
asset impairment and restructuring charges recognized during fiscal 2004 related
to the closing of six Bahama Breeze restaurants and write down of another four
Bahama Breeze restaurants, one Olive Garden restaurant and one Red Lobster
restaurant. Net earnings were also impacted by decreases in food and beverage
costs as a percent of sales, which were only partially offset by increases in
restaurant labor, restaurant expenses, selling, general, and administrative
expenses, and depreciation and amortization expense as a percent of sales. The
increase in diluted net earnings per share is due to a reduction in the average
diluted shares outstanding from fiscal 2003 to fiscal 2004 because of our
continuing repurchase of our common stock.
4
Net earnings for fiscal 2003 decreased 2.3 percent and diluted net earnings per
share increased 0.8 percent, compared to fiscal 2002. The decrease in net
earnings was primarily due to increases in restaurant labor, restaurant
expenses, and depreciation and amortization expenses as a percent of sales,
which were only partially offset by decreases in food and beverage costs and
selling, general, and administrative costs as a percent of sales. The increase
in diluted net earnings per share was due to a reduction in the average diluted
shares outstanding from fiscal 2002 to fiscal 2003 because of our continuing
repurchase of our common stock.
SEASONALITY
Our sales volumes fluctuate seasonally. During fiscal 2004, 2003, and 2002, our
sales were highest in the spring, lowest in the fall, and comparable during
winter and summer. Holidays, severe weather, and similar conditions may impact
sales volumes seasonally in some operating regions. Because of the seasonality
of our business, results for any quarter are not necessarily indicative of the
results that may be achieved for the full fiscal year.
IMPACT OF INFLATION
We do not believe inflation had a significant overall effect on our operations
during fiscal 2004, 2003, and 2002. We believe we have historically been able to
pass on increased operating costs through menu price increases and other
strategies.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America. 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 expenses during the reporting period. Actual
results could differ from those estimates.
Critical accounting policies are those we believe are both most important to the
portrayal of our financial condition and operating results, and require our most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain.
Judgments and uncertainties affecting the application of those policies may
result in materially different amounts being reported under different conditions
or using different assumptions. We consider the following policies to be most
critical in understanding the judgments that are involved in preparing our
consolidated financial statements.
Land, Buildings, and Equipment
Land, buildings, and equipment are recorded at cost less accumulated
depreciation. Building components are depreciated over estimated useful lives
ranging from seven to 40 years using the straight-line method. Leasehold
improvements, which are reflected on our consolidated balance sheets as a
component of buildings, are amortized over the lesser of the lease term or the
estimated useful lives of the related assets using the straight-line method.
Equipment is depreciated over estimated useful lives ranging from two to 10
years, also using the straight-line method. Accelerated depreciation methods are
generally used for income tax purposes.
Our accounting policies regarding land, buildings, and equipment, including
leasehold improvements, include our judgments regarding the estimated useful
lives of these assets, the residual values to which the assets are depreciated
or amortized, and the determination as to what constitutes enhancing the value
of or increasing the life of existing assets. These judgments and estimates may
produce materially different amounts of reported depreciation and amortization
expense if different assumptions were used. As discussed further below, these
judgments may also impact our need to recognize an impairment charge on the
carrying amount of these assets as the cash flows associated with the assets are
realized.
Impairment of Long-Lived Assets
Land, buildings, and equipment and certain other assets, including capitalized
software costs and liquor licenses, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of the assets to the future undiscounted net
cash flows expected to be generated by the assets. Identifiable cash flows are
measured at the lowest level for which they are largely independent of the cash
flows of other groups of assets and liabilities, generally at the restaurant
level. If these assets are determined to be impaired, the impairment recognized
is measured by the amount by which the carrying amount of the assets exceeds
their fair value. Fair value is generally determined based on appraisals or
sales prices of comparable assets. Restaurant sites and certain other assets to
be disposed of are reported at the lower of their carrying amount or fair value,
less estimated costs to sell. Restaurant sites and certain other assets to be
disposed of are included in assets held for
5
disposal when certain criteria are met. These criteria include the requirement
that the likelihood of disposing of these assets within one year is probable.
Those assets whose disposal is not probable within one year remain in land,
buildings, and equipment until their disposal is probable within one year.
The judgments we make related to the expected useful lives of long-lived assets
and our ability to realize undiscounted cash flows in excess of the carrying
amounts of these assets are affected by factors such as the ongoing maintenance
and improvements of the assets, changes in economic conditions, and changes in
usage or operating performance. As we assess the ongoing expected cash flows and
carrying amounts of our long-lived assets, significant adverse changes in these
factors could cause us to realize a material impairment charge. In fiscal 2004,
we recognized asset impairment charges of $37 million ($22 million after-tax)
for the closing of six Bahama Breeze restaurants and the write-down of four
other Bahama Breeze restaurants, one Olive Garden restaurant, and one Red
Lobster restaurant based on an evaluation of expected cash flows.
Self-Insurance Accruals
We self-insure a significant portion of expected losses under our workers'
compensation, employee medical, and general liability programs. Accrued
liabilities have been recorded based on our estimates of the ultimate costs to
settle incurred claims, both reported and not yet reported.
Our accounting policies regarding self-insurance programs include our judgments
and independent actuarial assumptions regarding economic conditions, the
frequency or severity of claims and claim development patterns, and claim
reserve, management, and settlement practices. Unanticipated changes in these
factors may produce materially different amounts of reported expense under these
programs.
Income Taxes
We estimate certain components of our provision for income taxes. These
estimates include, among other items, depreciation and amortization expense
allowable for tax purposes, allowable tax credits for items such as taxes paid
on reported employee tip income, effective rates for state and local income
taxes, and the tax deductibility of certain other items.
Our estimates are based on the best available information at the time that we
prepare the provision. We generally file our annual income tax returns several
months after our fiscal year-end. Income tax returns are subject to audit by
federal, state, and local governments, generally years after the returns are
filed. These returns could be subject to material adjustments or differing
interpretations of the tax laws.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows generated from operating activities provide us with a significant
source of liquidity. Since substantially all our sales are for cash and cash
equivalents, and accounts payable are generally due in five to 30 days, we are
able to carry current liabilities in excess of current assets. In addition to
cash flows from operations, we use a combination of long-term and short-term
borrowings to fund our capital needs.
We manage our business and our financial ratios to maintain an investment grade
bond rating, which allows flexible access to financing at reasonable costs.
Currently, our publicly issued long-term debt carries "Baa1" (Moody's Investors
Service), "BBB+" (Standard & Poor's) and "BBB+" (Fitch) ratings. Our commercial
paper has ratings of "P-2" (Moody's Investors Service), "A-2" (Standard &
Poor's) and "F-2" (Fitch). These ratings are as of the date of this annual
report and have been obtained with the understanding that Moody's Investors
Service, Standard & Poor's, and Fitch will continue to monitor our credit and
make future adjustments to these ratings to the extent warranted. The ratings
may be changed, superseded, or withdrawn at any time.
Our commercial paper program serves as our primary source of short-term
financing. At May 30, 2004, $15 million was outstanding under the program. To
support our commercial paper program, we have a credit facility under a Credit
Agreement dated October 17, 2003, as amended, with a consortium of banks,
including Wachovia Bank, N.A., as administrative agent, under which we can
borrow up to $400 million. The credit facility allows us to borrow at interest
rates based on a spread over (i) LIBOR or (ii) a base rate that is the higher of
the prime rate, or one-half of one percent above the federal funds rate, at our
option. The interest rate spread over LIBOR is determined by our debt rating.
The credit facility expires on October 17, 2008, and contains various
restrictive covenants, including a leverage test that requires us to maintain a
ratio of consolidated total debt to consolidated total capitalization of less
than 0.55 to 1.00 and a limitation of $25 million on priority debt, subject to
certain exceptions. The credit facility does not, however, contain a prohibition
on borrowing in the event of a ratings downgrade or a material adverse change in
and of itself. None of these covenants are expected to impact our liquidity or
capital resources. At May 30, 2004, we were in compliance with all covenants
under the Credit Agreement.
6
At May 30, 2004, our long-term debt consisted principally of: (1) $150 million
of unsecured 8.375 percent senior notes due in September 2005, (2) $150 million
of unsecured 6.375 percent notes due in February 2006, (3) $150 million of
unsecured 5.75 percent medium-term notes due in March 2007, (4) $75 million of
unsecured 7.45 percent medium-term notes due in April 2011, (5) $100 million of
unsecured 7.125 percent debentures due in February 2016, and (6) an unsecured,
variable rate, $29 million commercial bank loan due in December 2018 that
supports two loans from us to the Employee Stock Ownership Plan portion of the
Darden Savings Plan. Through a shelf registration on file with the Securities
and Exchange Commission (SEC), we may issue up to an additional $125 million of
unsecured debt securities from time to time. The debt securities may bear
interest at either fixed or floating rates, and may have maturity dates of nine
months or more after issuance.
A summary of our contractual obligations and commercial commitments at May 30,
2004, is as follows (in thousands):
- ---------------------------------------------------------------------------------------------------------------------
Payments Due by Period
- ---------------------------------------------------------------------------------------------------------------------
Contractual Less than 1-3 3-5 After 5
Obligations Total 1 Year Years Years Years
- ---------------------------------------------------------------------------------------------------------------------
Short-term debt $ 14,500 $ 14,500 $ -- $ -- $ --
- ---------------------------------------------------------------------------------------------------------------------
Long-term debt (1) 654,403 -- 450,000 -- 204,403
- ---------------------------------------------------------------------------------------------------------------------
Operating leases 373,699 62,070 108,218 80,009 123,402
- ---------------------------------------------------------------------------------------------------------------------
Purchase obligations (2) 670,019 575,836 94,183 -- --
- ---------------------------------------------------------------------------------------------------------------------
Total contractual cash
obligations $1,712,621 $ 652,406 $652,401 $ 80,009 $327,805
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
Amount of Commitment Expiration per Period
- ---------------------------------------------------------------------------------------------------------------------
Total Amounts
Other Commercial Committed Less than 1-3 3-5 After 5
Commitments 1 Year Years Years Years
- ---------------------------------------------------------------------------------------------------------------------
Trade letters of credit $ 242 $ 242 $ -- $ -- $ --
- ---------------------------------------------------------------------------------------------------------------------
Standby letters of
credit (3) 88,376 88,376 -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Guarantees (4) 4,346 796 1,488 1,147 915
- ---------------------------------------------------------------------------------------------------------------------
Other 2,125 750 1,375 -- --
- ---------------------------------------------------------------------------------------------------------------------
Total commercial
commitments $95,089 $90,164 $2,863 $1,147 $ 915
- ---------------------------------------------------------------------------------------------------------------------
<FN>
1) Excludes issuance discount of $1,054.
2) Includes commitments for food and beverage items and supplies, capital
projects, and other miscellaneous commitments.
3) Includes letters of credit for $72,480 of workers' compensation and general
liabilities accrued in our consolidated financial statements; also includes
letters of credit for $7,635 of lease payments included in contractual
operating lease obligation payments noted above.
4) Consists solely of guarantees associated with sub-leased properties. We are
not aware of any non-performance under these sub-lease arrangements that
would result in us having to perform in accordance with the terms of the
guarantees.
</FN>
As disclosed in Exhibit 12 to our Annual Report on Form 10-K, our fixed-charge
coverage ratio, which measures the number of times each year that we earn enough
to cover our fixed charges, amounted to 5.8 times and 6.0 times for the fiscal
years ended May 30, 2004 and May 25, 2003, respectively. Our adjusted debt to
adjusted total capital ratio (which includes 6.25 times the total annual
restaurant minimum rent ($56.5 million and $48.1 million for the fiscal years
ended May 30, 2004 and May 25, 2003, respectively) and 3.00 times the total
annual restaurant equipment minimum rent ($.1 million and $5.7 million for the
fiscal years ended May 30, 2004 and May 25, 2003, respectively) as components of
adjusted debt and adjusted total capital) was 45 percent at May 30, 2004 and May
25, 2003. We use the lease-debt equivalent in our adjusted debt to adjusted
total capital ratio as we believe its inclusion better represents the optimal
capital structure that we target from period to period.
7
Based on these ratios, we believe our financial condition is strong. The
composition of our capital structure is shown in the following table.
(In millions, except ratios) May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------
CAPITAL STRUCTURE
-------------------------------------------------------------------------------
Short-term debt $ 15 $ --
Long-term debt 653 658
Stockholders' equity 1,246 1,196
-------------------------------------------------------------------------------
Total capital $ 1,914 $ 1,854
===============================================================================
ADJUSTMENTS TO CAPITAL
-------------------------------------------------------------------------------
Short-term debt $ 15 $ --
Long-term debt 653 658
Lease-debt equivalent 353 318
-------------------------------------------------------------------------------
Adjusted debt $ 1,021 $ 976
Stockholders' equity 1,246 1,196
-------------------------------------------------------------------------------
Adjusted total capital $ 2,267 $ 2,172
===============================================================================
CAPITAL STRUCTURE RATIOS
-------------------------------------------------------------------------------
Debt to total capital ratio 35% 35%
Adjusted debt to adjusted total
capital ratio 45% 45%
===============================================================================
Net cash flows used in financing activities included our repurchase of 10.7
million shares of our common stock for $235 million in fiscal 2004, compared to
10.7 million shares for $213 million in fiscal 2003, and 9.0 million shares for
$209 million in fiscal 2002. Our Board of Directors has authorized us to
repurchase up to 115.4 million shares of our common stock. At May 30, 2004, a
total of 109.2 million shares have been repurchased under the authorization. The
repurchased common stock is reflected as a reduction of stockholders' equity.
Net cash flows used in financing activities also included dividends paid to
stockholders of $13 million, $14 million, and $9 million in fiscal 2004, 2003,
and 2002, respectively.
Net cash flows used in investing activities included capital expenditures
incurred principally for building new restaurants, replacing equipment, and
remodeling existing restaurants. Capital expenditures were $354 million in
fiscal 2004, compared to $423 million in fiscal 2003, and $318 million in fiscal
2002. The decreased expenditures in fiscal 2004 resulted primarily from
decreased spending associated with building fewer new restaurants and fewer
remodels. The increased expenditures in fiscal 2003 resulted primarily from
increased spending associated with building more new restaurants and replacing
equipment. We estimate that our fiscal 2005 capital expenditures will
approximate $360 million.
Net cash flows provided by operating activities for fiscal 2003 included a $20
million contribution to our defined benefit pension plans, which enabled the
plans to maintain a fully funded status as of the plans' February 28, 2003
annual valuation date. Less than $0.1 million was required to fund our defined
benefit pension plans in fiscal 2004 and fiscal 2002. Our defined benefit and
other postretirement benefit costs and liabilities are calculated using various
actuarial assumptions and methodologies prescribed under the Financial
Accounting Standards Board's (FASB) Statement of Financial Accounting Standards
(SFAS) No. 87, "Employers' Accounting for Pensions" and No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions". We use certain
assumptions including, but not limited to, the selection of a discount rate,
expected long-term rate of return on plan assets, and expected health care cost
trend rates. We set the discount rate assumption annually for each plan at its
valuation date to reflect the yield of high quality fixed-income debt
instruments, with lives that approximate the maturity of the plan benefits. At
May 30, 2004, our discount rate was 6.0 percent. The expected long-term rate of
return on plan assets and health care cost trend rates are based upon several
factors, including our historical assumptions compared with actual results, an
analysis of current market conditions, asset allocations, and the views of
leading financial advisers and economists. Based on our analysis during fiscal
2003, we lowered our defined benefit plans' expected long-term rate of return on
plan assets for fiscal 2004 from 10.4 percent to 9.0 percent. The change in our
defined benefit plans' expected long-term rate of return on plan assets
decreased earnings before income taxes by approximately $2 million in fiscal
2004. At May 30, 2004, our expected health care cost trend rates ranged from
11.0 percent to 12.0 percent for fiscal 2005, depending on the medical service
category. The rates gradually decrease to 5.0 percent through fiscal 2010 and
remain at that level thereafter.
The expected long-term rate of return on plan assets component of our net
periodic benefit cost is calculated based on the market-related value of plan
assets. Our target asset allocation is 35 percent U.S. equities, 30 percent
high-quality, long-duration fixed-income securities, 15 percent international
equities, 10 percent private equities, and 10 percent real assets. We monitor
our actual asset allocation to ensure that it approximates our target allocation
and
8
believe that our long-term asset allocation will continue to approximate our
target allocation. Our historical ten-year rate of return on plan assets,
calculated using the geometric method average of returns, is approximately 10.5
percent as of May 30, 2004.
We have an unrecognized net actuarial loss for the defined benefit plans and
postretirement benefit plan as of May 30, 2004, of $62 million and $6 million,
respectively. The unrecognized net actuarial loss represents changes in the
amount of the projected benefit obligation and plan assets resulting from
differences in the assumptions used and actual experience. The amortization of
the unrecognized net actuarial loss component of our fiscal 2005 net periodic
benefit cost for the defined benefit plans and postretirement benefit plan is
expected to be approximately $5 million and $0.3 million, respectively.
We believe our defined benefit and postretirement benefit plan assumptions are
appropriate based upon the factors discussed above. However, other assumptions
could also be reasonably applied that could differ from the assumptions used. A
quarter percentage point change in the defined benefit plans' discount rate and
the expected long-term rate of return on plan assets would increase or decrease
earnings before income taxes by $0.8 million and $0.4 million, respectively. A
quarter percentage point change in our postretirement benefit plan discount rate
would increase or decrease earnings before income taxes by $0.1 million. A one
percentage point increase in the health care cost trend rates would have
increased the accumulated postretirement benefit obligation (APBO) by $4 million
at May 30, 2004, and the aggregate of the service cost and interest cost
components of net periodic postretirement benefit cost by $0.3 million for
fiscal 2004. A one percentage point decrease in the health care cost trend rates
would have decreased the APBO by $3 million at May 30, 2004, and the aggregate
of the service cost and interest cost components of net periodic postretirement
benefit cost by $0.3 million for fiscal 2004. These changes in assumptions would
not significantly impact our funding requirements.
We are not aware of any trends or events that would materially affect our
capital requirements or liquidity. We believe that our internal cash-generating
capabilities, borrowings available under our shelf registration for unsecured
debt securities, and short-term commercial paper program should be sufficient to
finance our capital expenditures, stock repurchase program, and other operating
activities through fiscal 2005.
OFF-BALANCE SHEET ARRANGEMENTS
We are not a party to any off-balance sheet arrangements that have, or are
reasonably likely to have, a current or future material effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures, or capital resources.
FINANCIAL CONDITION
Our current assets totaled $346 million at May 30, 2004, compared to $326
million at May 25, 2003. The increase resulted primarily from increases in
inventories of $25 million that resulted from opportunistic product purchases
made during fiscal 2004.
Our current liabilities were $683 million at May 30, 2004, compared to $640
million at May 25, 2003. At May 30, 2004, $15 million of short-term debt was
outstanding under our commercial paper program, which was used to fund current
operations and capital expenditures. Accrued payroll of $103 million at May 30,
2004, increased from $86 million at May 25, 2003, principally due to higher
incentive compensation earned in fiscal 2004. Other current liabilities of $228
million at May 30, 2004, increased from $202 million at May 25, 2003,
principally due to a $19 million increase in liabilities associated with our
non-qualified deferred compensation plan and a $7 million increase in sales tax
payable as a result of higher fourth quarter sales in fiscal 2004. Accrued
income taxes of $49 million at May 30, 2004, decreased from $68 million at May
25, 2003, principally due to timing of income tax payments made and changes in
temporary differences included in the deferred tax balances associated with
current income tax deductions for certain land, buildings, and equipment. The
$19 million decrease in accrued income taxes is offset by the related increase
in net non-current deferred income tax liabilities at May 30, 2004.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to a variety of market risks, including fluctuations in interest
rates, foreign currency exchange rates, and commodity prices. To manage this
exposure, we periodically enter into interest rate, foreign currency exchange,
and commodity instruments for other than trading purposes (see Notes 1 and 8 of
the Notes to Consolidated Financial Statements).
We use the variance/covariance method to measure value at risk, over time
horizons ranging from one week to one year, at the 95 percent confidence level.
At May 30, 2004, our potential losses in future net earnings resulting from
changes in foreign currency exchange rate instruments, commodity instruments,
and floating rate debt interest rate exposures were approximately $2 million
over a period of one year (including the impact of the interest rate swap
9
agreements discussed in Note 8 to the Notes to Consolidated Financial
Statements). The value at risk from an increase in the fair value of all of our
long-term fixed rate debt, over a period of one year, was approximately $22
million. The fair value of our long-term fixed rate debt during fiscal 2004
averaged $690 million, with a high of $714 million and a low of $669 million.
Our interest rate risk management objective is to limit the impact of interest
rate changes on earnings and cash flows by targeting an appropriate mix of
variable and fixed rate debt.
FORWARD-LOOKING STATEMENTS
Certain statements included in this report and other materials filed or to be
filed by us with the SEC (as well as information included in oral or written
statements made or to be made by us) may contain statements that are
forward-looking within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Words or phrases such as "believe," "plan," "will," "expect," "intend,"
"estimate," and "project," and similar expressions are intended to identify
forward-looking statements. All of these statements, and any other statements in
this report that are not historical facts, are forward-looking. Examples of
forward-looking statements include, but are not limited to, projections
regarding: our growth plans and the number and type of expected new restaurant
openings; same-restaurant sales growth for Red Lobster and Olive Garden; diluted
net earnings per share growth in fiscal 2005; and expectations regarding when
Bahama Breeze and Smokey Bones will become accretive to earnings. These
forward-looking statements are based on assumptions concerning important
factors, risks, and uncertainties that could significantly affect anticipated
results in the future and, accordingly, could cause the actual results to differ
materially from those expressed in the forward-looking statements. These
factors, risks, and uncertainties include, but are not limited to:
o the highly competitive nature of the restaurant industry, especially
pricing, service, location, personnel, and type and quality of food;
o economic, market, and other conditions, including a protracted economic
slowdown or worsening economy, industry-wide cost pressures, public safety
conditions (including ongoing concerns about terrorism threats or the
continuing conflict in Iraq), weak consumer demand, changes in consumer
preferences, demographic trends, weather conditions, construction costs,
and the cost and availability of borrowed funds;
o the price and availability of food, labor, utilities, insurance and media,
and other costs, including seafood costs, employee benefits, workers'
compensation insurance, litigation costs, and the general impact of
inflation;
o unfavorable publicity relating to food safety or other concerns, including
litigation alleging poor food quality, food-borne illness, or personal
injury;
o the availability of desirable restaurant locations;
o government regulations and litigation relating to federal and state labor
laws, zoning, land use, environmental matters, and liquor licenses; and
o growth plans, including real estate development and construction
activities, the issuance and renewal of licenses and permits for restaurant
development, and the availability of funds to finance growth.
10
REPORT OF MANAGEMENT RESPONSIBILITIES
The management of Darden Restaurants, Inc. is responsible for the fairness and
accuracy of the consolidated financial statements. The consolidated financial
statements have been prepared in accordance with U.S. generally accepted
accounting principles, using management's best estimates and judgments where
appropriate. The financial information throughout this report is consistent with
our consolidated financial statements.
Management has established a system of internal controls that provides
reasonable assurance that assets are adequately safeguarded, and transactions
are recorded accurately, in all material respects, in accordance with
management's authorization. We maintain a strong audit program that
independently evaluates the adequacy and effectiveness of internal controls. Our
internal controls provide for appropriate segregation of duties and
responsibilities, and there are documented policies regarding utilization of our
assets and proper financial reporting. These formally stated and regularly
communicated policies set high standards of ethical conduct for all employees.
The Audit Committee of the Board of Directors meets at least quarterly to
determine that management, internal auditors, and the independent registered
public accounting firm are properly discharging their duties regarding internal
control and financial reporting. The independent registered public accounting
firm, internal auditors, and employees have full and free access to the Audit
Committee at any time.
KPMG LLP, an independent registered public accounting firm, is retained to audit
our consolidated financial statements. Their report follows.
/s/ Joe R. Lee
Joe R. Lee
Chairman of the Board and Chief Executive Officer
11
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Darden Restaurants, Inc.
We have audited the accompanying consolidated balance sheets of Darden
Restaurants, Inc. and subsidiaries as of May 30, 2004, and May 25, 2003, and the
related consolidated statements of earnings, changes in stockholders' equity and
accumulated other comprehensive income (loss), and cash flows for each of the
years in the three-year period ended May 30, 2004. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Darden Restaurants,
Inc. and subsidiaries as of May 30, 2004, and May 25, 2003, and the results of
their operations and their cash flows for each of the years in the three-year
period ended May 30, 2004, in conformity with U.S. generally accepted accounting
principles.
/s/ KPMG LLP
Tampa, Florida
June 18, 2004
12
CONSOLIDATED STATEMENTS OF EARNINGS
Fiscal Year Ended
-------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data) May 30, 2004 May 25, 2003 May 26, 2002
-------------------------------------------------------------------------------------------------------------------
Sales $5,003,355 $4,654,971 $4,366,911
Costs and expenses:
Cost of sales:
Food and beverage 1,526,875 1,449,162 1,384,481
Restaurant labor 1,601,258 1,485,046 1,373,416
Restaurant expenses 767,584 703,554 628,701
-------------------------------------------------------------------------------------------------------------------
Total cost of sales, excluding restaurant
depreciation and amortization of $195,486,
$177,127, and $155,837, respectively $3,895,717 $3,637,762 $3,386,598
Selling, general, and administrative 472,109 431,722 417,158
Depreciation and amortization 210,004 191,218 165,829
Interest, net 43,659 42,597 36,585
Asset impairment and restructuring charges (credits), net 41,868 3,924 (2,568)
-------------------------------------------------------------------------------------------------------------------
Total costs and expenses $4,663,357 $4,307,223 $4,003,602
-------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 339,998 347,748 363,309
Income taxes 108,536 115,488 125,521
-------------------------------------------------------------------------------------------------------------------
Net earnings $ 231,462 $ 232,260 $ 237,788
===================================================================================================================
Net earnings per share:
Basic $ 1.42 $ 1.36 $ 1.36
Diluted $ 1.36 $ 1.31 $ 1.30
===================================================================================================================
Average number of common shares outstanding:
Basic 163,500 170,300 174,700
Diluted 169,700 177,400 183,500
===================================================================================================================
See accompanying notes to consolidated financial statements.
13
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------------------------------------------
(In thousands) May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 36,694 $ 48,630
Receivables 30,258 29,023
Inventories 198,781 173,644
Prepaid expenses and other current assets 25,316 25,126
Deferred income taxes 55,258 49,206
-------------------------------------------------------------------------------------------------------------------
Total current assets $ 346,307 $ 325,629
Land, buildings, and equipment 2,250,616 2,157,132
Other assets 183,425 181,872
-------------------------------------------------------------------------------------------------------------------
Total assets $ 2,780,348 $ 2,664,633
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 174,624 $ 175,991
Short-term debt 14,500 --
Accrued payroll 103,327 85,975
Accrued income taxes 48,753 67,975
Other accrued taxes 38,440 35,069
Unearned revenues 75,513 72,698
Other current liabilities 228,324 202,201
-------------------------------------------------------------------------------------------------------------------
Total current liabilities $ 683,481 $ 639,909
Long-term debt 653,349 658,086
Deferred income taxes 176,216 150,537
Other liabilities 21,532 19,910
-------------------------------------------------------------------------------------------------------------------
Total liabilities $ 1,534,578 $ 1,468,442
-------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock and surplus, no par value. Authorized
500,000 shares; issued 264,907 and 261,463 shares,
respectively; outstanding 158,431 and 164,950 shares,
respectively $ 1,584,115 $ 1,525,957
Preferred stock, no par value. Authorized 25,000 shares;
none issued and outstanding -- --
Retained earnings 1,197,921 979,443
Treasury stock, 106,476 and 96,513 shares,
at cost, respectively (1,483,768) (1,254,293)
Accumulated other comprehensive income (loss) (9,959) (10,489)
Unearned compensation (41,401) (42,848)
Officer notes receivable (1,138) (1,579)
-------------------------------------------------------------------------------------------------------------------
Total stockholders' equity $ 1,245,770 $ 1,196,191
-------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 2,780,348 $ 2,664,633
===================================================================================================================
See accompanying notes to consolidated financial statements.
14
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND ACCUMULATED OTHER
COMPREHENSIVE INCOME (LOSS)
- --------------------------------------------------------------------------------------------------------------------------------
Common Accumulated
Stock Other Officer Total
and Retained Treasury Comprehensive Unearned Notes Stockholders'
(In thousands, except per share data) Surplus Earnings Stock Income (Loss) Compensation Receivable Equity
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 27, 2001 $1,405,799 $ 532,121 $ (840,254) $(13,102) $(49,322) $(1,924) $1,033,318
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net earnings -- 237,788 -- -- -- -- 237,788
Other comprehensive income (loss):
Foreign currency adjustment -- -- -- 169 -- -- 169
Change in fair value of derivatives,
net of tax of $234 -- -- -- 380 -- -- 380
Minimum pension liability adjustment,
net of tax benefit of $177 -- -- -- (288) -- -- (288)
-----------
Total comprehensive income 238,049
Cash dividends declared ($0.053 per share) -- (9,225) -- -- -- -- (9,225)
Stock option exercises (4,310 shares) 34,742 -- 1,364 -- -- -- 36,106
Issuance of restricted stock (438 shares),
net of forfeiture adjustments 5,666 -- 815 -- (6,493) -- (12)
Earned compensation -- -- -- -- 4,392 -- 4,392
ESOP note receivable repayments -- -- -- -- 5,315 -- 5,315
Income tax benefits credited to equity 24,989 -- -- -- -- -- 24,989
Purchases of common stock for treasury
(8,972 shares) -- -- (208,578) -- -- -- (208,578)
Issuance of treasury stock under Employee
Stock Purchase Plan and other plans
(290 shares) 2,858 -- 1,738 -- -- -- 4,596
Issuance of officer notes, net -- -- -- -- -- (73) (73)
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 26, 2002 $1,474,054 $ 760,684 $(1,044,915) $(12,841) $(46,108) $(1,997) $1,128,877
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net earnings -- 232,260 -- -- -- -- 232,260
Other comprehensive income (loss):
Foreign currency adjustment -- -- -- 2,579 -- -- 2,579
Change in fair value of derivatives,
net of tax of $0 -- -- -- 2 -- -- 2
Minimum pension liability adjustment,
net of tax benefit of $141 -- -- -- (229) -- -- (229)
-----------
Total comprehensive income 234,612
Cash dividends declared ($0.080 per share) -- (13,501) -- -- -- -- (13,501)
Stock option exercises (3,133 shares) 27,261 -- 1,652 -- -- -- 28,913
Issuance of restricted stock (148 shares),
net of forfeiture adjustments 4,429 -- 600 -- (5,029) -- --
Earned compensation -- -- -- -- 3,579 -- 3,579
ESOP note receivable repayments -- -- -- -- 4,710 -- 4,710
Income tax benefits credited to equity 16,385 -- -- -- -- -- 16,385
Purchases of common stock for treasury
(10,746 shares) -- -- (213,311) -- -- -- (213,311)
Issuance of treasury stock under Employee
Stock Purchase Plan and other plans
(280 shares) 3,828 -- 1,681 -- -- -- 5,509
Issuance of officer notes, net -- -- -- -- -- 418 418
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 25, 2003 $1,525,957 $ 979,443 $(1,254,293) $(10,489) $(42,848) $(1,579) $1,196,191
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net earnings -- 231,462 -- -- -- -- 231,462
Other comprehensive income (loss):
Foreign currency adjustment -- -- -- 394 -- -- 394
Change in fair value of derivatives,
net of tax of $51 -- -- -- 205 -- -- 205
Minimum pension liability adjustment,
net of tax benefit of $45 -- -- -- (69) -- -- (69)
----------
Total comprehensive income 231,992
Cash dividends declared ($0.080 per share) -- (12,984) -- -- -- -- (12,984)
Stock option exercises (3,464 shares) 30,972 -- 3,685 -- -- -- 34,657
Issuance of restricted stock (409 shares),
net of forfeiture adjustments 7,605 -- 173 -- (7,778) -- --
Earned compensation -- -- -- -- 4,198 -- 4,198
ESOP note receivable repayments -- -- -- -- 5,027 -- 5,027
Income tax benefits credited to equity 15,650 -- -- -- -- -- 15,650
Purchases of common stock for treasury
(10,749 shares) -- -- (235,462) -- -- -- (235,462)
Issuance of treasury stock under Employee
Stock Purchase Plan and other plans
(357 shares) 3,931 -- 2,129 -- -- -- 6,060
Issuance of officer notes, net -- -- -- -- -- 441 441
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 30, 2004 $1,584,115 $1,197,921 $(1,483,768) $ (9,959) $(41,401) $(1,138) $1,245,770
================================================================================================================================
See accompanying notes to consolidated financial statements.
15
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended
-------------------------------------------------------------------------------------------------------------------
(In thousands) May 30, 2004 May 25, 2003 May 26, 2002
-------------------------------------------------------------------------------------------------------------------
Cash flows - operating activities
Net earnings $ 231,462 $ 232,260 $ 237,788
Adjustments to reconcile net earnings to cash flows:
Depreciation and amortization 210,004 191,218 165,829
Asset impairment charges, net 40,756 4,282 --
Restructuring charge (credit) 1,112 (358) (2,568)
Amortization of unearned compensation and loan costs 7,599 6,901 7,578
Change in current assets and liabilities 2,207 36,046 49,604
Change in other liabilities 1,794 420 (496)
Contribution to defined benefit pension plans and
postretirement plan (257) (20,203) (164)
Loss on disposal of land, buildings, and equipment 104 2,456 1,803
Change in cash surrender value of trust-owned life
insurance (6,106) 2,441 743
Deferred income taxes 19,621 35,890 22,743
Income tax benefits credited to equity 15,650 16,385 24,989
Non-cash compensation expense 861 758 --
Other, net 604 139 252
-------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 525,411 $ 508,635 $ 508,101
-------------------------------------------------------------------------------------------------------------------
Cash flows - investing activities
Purchases of land, buildings, and equipment (354,326) (423,273) (318,392)
Increase in other assets (5,128) (8,100) (24,700)
Purchase of trust-owned life insurance -- (6,000) (31,500)
Proceeds from disposal of land, buildings, and equipment 16,197 7,641 10,741
Proceeds from maturities of (purchases of) short-term
investments -- 10,000 (9,904)
-------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities $(343,257) $(419,732) $(373,755)
-------------------------------------------------------------------------------------------------------------------
Cash flows - financing activities
Proceeds from issuance of common stock 39,856 33,664 40,520
Dividends paid (12,984) (13,501) (9,225)
Purchases of treasury stock (235,462) (213,311) (208,578)
ESOP note receivable repayments 5,027 4,710 5,315
Increase (decrease) in short-term debt 14,500 -- (12,000)
Proceeds from issuance of long-term debt -- -- 149,655
Repayment of long-term debt (5,027) (4,710) (7,962)
Payment of loan costs -- -- (1,010)
-------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities $(194,090) $(193,148) $ (43,285)
-------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents (11,936) (104,245) 91,061
Cash and cash equivalents - beginning of year 48,630 152,875 61,814
-------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents - end of year $ 36,694 $ 48,630 $ 152,875
===================================================================================================================
Cash flows from changes in current assets and liabilities
Receivables (279) 66 3,781
Inventories (25,137) (1,231) (23,984)
Prepaid expenses and other current assets (190) (8,523) 1,987
Accounts payable (1,027) 15,927 3,205
Accrued payroll 17,352 (1,961) 5,348
Accrued income taxes (19,222) (529) 20,806
Other accrued taxes 3,371 4,595 3,045
Unearned revenues 2,815 16,066 18,487
Other current liabilities 24,524 11,636 16,929
-------------------------------------------------------------------------------------------------------------------
Change in current assets and liabilities $ 2,207 $ 36,046 $ 49,604
===================================================================================================================
See accompanying notes to consolidated financial statements.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations and Principles of Consolidation
The consolidated financial statements include the operations of Darden
Restaurants, Inc. and its wholly owned subsidiaries. We own and operate various
restaurant concepts located in the United States and Canada, with no
franchising. We also license 38 restaurants in Japan. All significant
intercompany balances and transactions have been eliminated in consolidation.
Fiscal Year
Our fiscal year ends on the last Sunday in May. Fiscal 2004 consisted of 53
weeks of operation. Fiscal 2003 and 2002 both consisted of 52 weeks of
operation.
Cash Equivalents
Cash equivalents include highly liquid investments such as U.S. treasury bills,
taxable municipal bonds, and money market funds that have a maturity of three
months or less. Amounts receivable from credit card companies are also
considered cash equivalents because they are both short-term and highly liquid
in nature and are typically converted to cash within three days of the sales
transaction.
Inventories
Inventories are valued at the lower of weighted-average cost or market.
Land, Buildings, and Equipment
Land, buildings, and equipment are recorded at cost less accumulated
depreciation. Building components are depreciated over estimated useful lives
ranging from seven to 40 years using the straight-line method. Leasehold
improvements, which are a component of buildings, are amortized over the lesser
of the lease term or the estimated useful lives of the related assets using the
straight-line method. Equipment is depreciated over estimated useful lives
ranging from two to ten years also using the straight-line method. Accelerated
depreciation methods are generally used for income tax purposes. Depreciation
and amortization expense associated with land, buildings, and equipment amounted
to $203,349, $184,963 and $162,784, in fiscal 2004, 2003, and 2002,
respectively. In fiscal 2004, 2003, and 2002, we had losses on disposal of land,
buildings, and equipment of $104, $2,456, and $1,803, respectively, which were
included in selling, general, and administrative expenses.
Capitalized Software Costs
Capitalized software, which is a component of other assets, is recorded at cost
less accumulated amortization. Capitalized software is amortized using the
straight-line method over estimated useful lives ranging from three to ten
years. The cost of capitalized software at May 30, 2004, and May 25, 2003,
amounted to $46,629 and $44,018, respectively. Accumulated amortization as of
May 30, 2004, and May 25, 2003, amounted to $14,301 and $9,963, respectively.
Amortization expense associated with capitalized software amounted to $6,655,
$6,255, and $3,045, in fiscal 2004, 2003, and 2002, respectively.
Trust-Owned Life Insurance
In August 2001, we caused a trust that we previously had established to purchase
life insurance policies covering certain of our officers and other key employees
(trust-owned life insurance or TOLI). The trust is the owner and sole
beneficiary of the TOLI policies. The policies were purchased to offset a
portion of our obligations under our non-qualified deferred compensation plan.
The cash surrender value of the policies is included in other assets while
changes in cash surrender value are included in selling, general, and
administrative expenses.
Liquor Licenses
The costs of obtaining non-transferable liquor licenses that are directly issued
by local government agencies for nominal fees are expensed as incurred. The
costs of purchasing transferable liquor licenses through open markets in
jurisdictions with a limited number of authorized liquor licenses are
capitalized. Annual liquor license renewal fees are expensed.
Impairment of Long-Lived Assets
Land, buildings, and equipment and certain other assets, including capitalized
software costs and liquor licenses, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying
17
amount of the assets to the future undiscounted net cash flows expected to be
generated by the assets. Identifiable cash flows are measured at the lowest
level for which they are largely independent of the cash flows of other groups
of assets and liabilities, generally at the restaurant level. If such assets are
determined to be impaired, the impairment recognized is measured by the amount
by which the carrying amount of the assets exceeds their fair value. Fair value
is generally determined based on appraisals or sales prices of comparable
assets. Restaurant sites and certain other assets to be disposed of are reported
at the lower of their carrying amount or fair value, less estimated costs to
sell. Restaurant sites and certain other assets to be disposed of are included
in assets held for disposal when certain criteria are met. These criteria
include the requirement that the likelihood of disposing of these assets within
one year is probable. Those assets whose disposal is not probable within one
year remain in land, buildings, and equipment until their disposal is probable
within one year.
Self-Insurance Accruals
We self-insure a significant portion of expected losses under our workers'
compensation, employee medical, and general liability programs. Accrued
liabilities have been recorded based on our estimates of the ultimate costs to
settle incurred claims, both reported and unreported.
Revenue Recognition
Revenue from restaurant sales is recognized when food and beverage products are
sold. Unearned revenues represent our liability for gift cards and certificates
that have been sold but not yet redeemed and are recorded at their expected
redemption value. When the gift cards and certificates are redeemed, we
recognize restaurant sales and reduce unearned revenues.
Food and Beverage Costs
Food and beverage costs include inventory, warehousing, and related purchasing
and distribution costs. Vendor allowances received in connection with the
purchase of a vendor's products are recognized as a reduction of the related
food and beverage costs as earned. These allowances are recognized as earned in
accordance with the underlying agreement with the vendor and completion of the
earning process. Vendor agreements are generally for a period of one year or
less and payments received are recorded as a current liability until earned.
Income Taxes
We provide for federal and state income taxes currently payable as well as for
those deferred because of temporary differences between reporting income and
expenses for financial statement purposes versus tax purposes. Federal income
tax credits are recorded as a reduction of income taxes. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in earnings in the period that includes the
enactment date.
Income tax benefits credited to equity relate to tax benefits associated with
amounts that are deductible for income tax purposes but do not affect earnings.
These benefits are principally generated from employee exercises of
non-qualified stock options and vesting of employee restricted stock awards.
Derivative Instruments and Hedging Activities
We account for derivative financial instruments and hedging activities in
accordance with the Financial Accounting Standards Board's (FASB) Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" and SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities - an Amendment of FASB
Statement No. 133." SFAS No. 133 and SFAS No. 138 require that all derivative
instruments be recorded on the balance sheet at fair value. We use financial and
commodities derivatives to manage interest rate and commodities pricing risks
inherent in our business operations. Our use of derivative instruments is
currently limited to interest rate hedges and commodities futures contracts.
These instruments are structured as hedges of forecasted transactions or the
variability of cash flows to be paid related to a recognized asset or liability
(cash flow hedges). No derivative instruments are entered into for trading or
speculative purposes. All derivatives are recognized on the balance sheet at
fair value. On the date the derivative contract is entered into, we document all
relationships between hedging instruments and hedged items, as well as our
risk-management objective and strategy for undertaking the various hedge
transactions. This process includes linking all derivatives designated as cash
flow hedges to specific assets and liabilities on the consolidated balance sheet
or to specific forecasted transactions. We also formally assess, both at the
hedge's inception and on an ongoing basis, whether the derivatives used in
hedging transactions are highly effective in offsetting changes in cash flows of
hedged items.
18
Changes in the fair value of derivatives that are highly effective and that are
designated and qualify as cash flow hedges are recorded in other comprehensive
income until earnings are affected by the variability in cash flows of the
designated hedged item. Where applicable, we discontinue hedge accounting
prospectively when it is determined that the derivative is no longer effective
in offsetting changes in the cash flows of the hedged item or the derivative is
terminated. Any changes in the fair value of a derivative where hedge accounting
has been discontinued or is ineffective are recognized immediately in earnings.
Cash flows related to derivatives are included in operating activities.
Pre-Opening Expenses
Non-capital expenditures associated with opening new restaurants are expensed as
incurred.
Advertising
Production costs of commercials are charged to operations in the fiscal period
the advertising is first aired. The costs of programming and other advertising,
promotion, and marketing programs are charged to operations in the fiscal period
incurred. Advertising expense amounted to $210,989, $200,020, and $184,163, in
fiscal 2004, 2003, and 2002, respectively.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages the use of a
fair-value method of accounting for stock-based awards under which the fair
value of stock options is determined on the date of grant and expensed over the
vesting period. As allowed by SFAS No. 123, we have elected to account for our
stock-based compensation plans under an intrinsic value method that requires
compensation expense to be recorded only if, on the date of grant, the current
market price of our common stock exceeds the exercise price the employee must
pay for the stock. Our policy is to grant stock options at the fair market value
of our underlying stock on the date of grant. Accordingly, no compensation
expense has been recognized for stock options granted under any of our stock
plans because the exercise price of all options granted was equal to the current
market value of our stock on the grant date. In December 2002, the FASB issued
SFAS No. 148, "Accounting for Stock-Based Compensation." SFAS No. 148 provides
alternative methods of transition for voluntary change to the fair value method
of accounting for stock-based compensation. In addition, SFAS No. 148 requires
more prominent disclosures in both annual and interim financial statements about
the method of accounting for stock-based compensation and the effect of the
method used on reported results.
Had we determined compensation expense for our stock options based on the fair
value at the grant date as prescribed under SFAS No. 123, our net earnings and
net earnings per share would have been reduced to the pro forma amounts
indicated below:
Fiscal Year
-------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------------------------
Net earnings, as reported $ 231,462 $ 232,260 $ 237,788
Add: Stock-based compensation expense
included in reported net earnings,
net of related tax effects 3,158 2,642 2,695
Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net
of related tax effects (17,980) (19,801) (18,386)
-----------------------------------
Pro forma $ 216,640 $ 215,101 $ 222,097
===================================
Basic net earnings per share
As reported $ 1.42 $ 1.36 $ 1.36
Pro forma $ 1.33 $ 1.26 $ 1.27
Diluted net earnings per share
As reported $ 1.36 $ 1.31 $ 1.30
Pro forma $ 1.28 $ 1.22 $ 1.21
===============================================================================
To determine pro forma net earnings, reported net earnings have been adjusted
for compensation expense associated with stock options granted that are expected
to eventually vest. The preceding pro forma results were determined using the
Black Scholes option-pricing model, which values options based on the stock
price at the grant date, the expected life of the option, the estimated
volatility of the stock, expected dividend payments, and the risk-free interest
rate over the expected life of the option. The dividend yield was calculated by
dividing the current annualized dividend by the option exercise price for each
grant. The expected volatility was determined considering stock prices for the
fiscal year the grant occurred and prior fiscal years, as well as considering
industry volatility data. The risk-free interest rate was the rate available on
zero coupon U.S. government obligations with a term equal to the expected life
of each grant. The expected life of the option was estimated based on the
exercise history from previous grants.
19
The weighted-average assumptions used in the Black Scholes model were as
follows:
Stock Options
Granted in Fiscal Year
-------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------------------------
Risk-free interest rate 2.62% 4.37% 4.50%
Expected volatility of stock 30.0% 30.0% 30.0%
Dividend yield 0.2% 0.2% 0.1%
Expected option life 6.0 years 6.0 years 6.0 years
===============================================================================
Restricted stock and restricted stock unit (RSU) awards are recognized as
unearned compensation, a component of stockholders' equity, based on the fair
market value of our common stock on the award date. These amounts are amortized
to compensation expense, using the straight-line method, over the vesting period
using assumed forfeiture rates for different types of awards. Compensation
expense is adjusted in future periods if actual forfeiture rates differ from
initial estimates.
Net Earnings Per Share
Basic net earnings per share are computed by dividing net earnings by the
weighted-average number of common shares outstanding for the reporting period.
Diluted net earnings per share reflect the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or
converted into common stock. Outstanding stock options issued by us represent
the only dilutive effect reflected in diluted weighted-average shares
outstanding. Options do not impact the numerator of the diluted net earnings per
share computation.
Options to purchase 4,643,389 shares, 3,952,618 shares, and 161,220 shares of
common stock were excluded from the calculation of diluted net earnings per
share for fiscal 2004, 2003, and 2002, respectively, because their exercise
prices exceeded the average market price of common shares for the period.
Comprehensive Income (Loss)
Comprehensive income (loss) includes net earnings and other comprehensive income
(loss) items that are excluded from net earnings under U.S. generally accepted
accounting principles. Other comprehensive income (loss) items include foreign
currency translation adjustments, the effective unrealized portion of changes in
the fair value of cash flow hedges, and amounts associated with minimum pension
liability adjustments.
Foreign Currency
The Canadian dollar is the functional currency for our Canadian restaurant
operations. Assets and liabilities denominated in Canadian dollars are
translated into U.S. dollars using the exchange rates in effect at the balance
sheet date. Results of operations are translated using the average exchange
rates prevailing throughout the period. Translation gains and losses are
reported as a separate component of accumulated other comprehensive income
(loss) in stockholders' equity. Aggregate cumulative translation losses were
$9,960 and $10,354 at May 30, 2004, and May 25, 2003, respectively. Gains
(losses) from foreign currency transactions, which amounted to $(53), $(105),
and $33, are included in the consolidated statements of earnings for fiscal
2004, 2003, and 2002, respectively.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles 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 expenses during the reporting period. Actual
results could differ from those estimates.
Segment Reporting
As of May 30, 2004, we operated 1,325 Red Lobster, Olive Garden, Bahama Breeze,
Smokey Bones Barbeque & Grill and Seasons 52 restaurants in North America as
part of a single operating segment. The restaurants operate principally in the
U.S. within the casual dining industry, providing similar products to similar
customers. The restaurants also possess similar pricing structures, resulting in
similar long-term expected financial performance characteristics. Revenues from
external customers are derived principally from food and beverage sales. We do
not rely on any major customers as a source of revenue. We believe we meet the
criteria for aggregating our operations into a single reporting segment.
20
Reclassifications
Certain reclassifications, including the reclassification of asset impairment
charges and credits from selling, general, and administrative expenses, have
been made to prior year amounts to conform to current year presentation.
Adoption of New Accounting Standards
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 establishes accounting standards for the recognition
and measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. SFAS No. 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002. We adopted SFAS No. 143 in the first quarter of fiscal 2004. Adoption
of SFAS No. 143 did not materially impact our consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51." Interpretation No.
46, which was revised in December 2003, addresses the consolidation by business
enterprises of variable interest entities as defined in the Interpretation.
Interpretation No. 46 is effective for interests in structures that are commonly
referred to as special-purpose entities for periods ending after December 15,
2003. Interpretation No. 46 is also effective for all other types of variable
interest entities for periods ending after March 15, 2004. We do not have any
interests that would change our current consolidated reporting entity or require
additional disclosures required by Interpretation No. 46.
In April 2003, the FASB issued SFAS No. 149, "Amendment to Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement is effective for hedging relationships
designated and contracts entered into or modified after June 30, 2003, except
for the provisions that relate to SFAS No. 133 implementation issues, which will
continue to be applied in accordance with their respective dates. We adopted
SFAS No. 149 in the first quarter of fiscal 2004. Adoption of SFAS No. 149 did
not materially impact our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes accounting standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. It requires certain financial instruments that were previously
classified as equity to be classified as assets or liabilities. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period starting
after June 15, 2003. We adopted SFAS No. 150 in the second quarter of fiscal
2004. Adoption of SFAS No. 150 did not materially impact our consolidated
financial statements.
In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." SFAS No. 132, as revised,
establishes additional disclosures for defined benefit pension and other
postretirement plans. It requires additional annual disclosures about the
assets, obligations, cash flows, net periodic benefit cost and other
quantitative and qualitative information regarding defined benefit pension and
other postretirement plans. It also requires quarterly disclosures of the
components of the net periodic benefit cost recognized for each period presented
and significant changes in the estimated amount of annual contributions
previously disclosed for defined benefit pension and other postretirement plans.
The additional disclosure requirements of SFAS No. 132, as revised, are
effective for annual periods ending after December 15, 2003, and interim periods
beginning after December 15, 2003. We adopted the additional disclosure
requirements of SFAS No. 132 in the fourth quarter of fiscal 2004. Adoption of
the additional disclosure requirements of SFAS No. 132 did not materially impact
our consolidated financial statements.
NOTE 2 - ACCOUNTS RECEIVABLE
Our accounts receivable is primarily comprised of receivables from national
storage and distribution companies with which we contract to provide services
that are billed to us on a per-case basis. In connection with these services,
certain of our inventory items are conveyed to these storage and distribution
companies to transfer ownership and risk of loss prior to delivery of the
inventory to our restaurants. We reacquire these items when the inventory is
subsequently delivered to our restaurants. These transactions do not impact the
consolidated statements of earnings. Receivables from national storage and
distribution companies amounted to $20,276 and $19,628 at May 30, 2004, and May
25, 2003, respectively. The allowance for doubtful accounts associated with all
of our receivables amounted to $350 and $330 at May 30, 2004, and May 25, 2003,
respectively.
21
NOTE 3 - RESTRUCTURING AND ASSET IMPAIRMENT ACTIVITIES
During fiscal 2004, we recorded pre-tax asset impairment charges of $36,526 for
long-lived asset impairments associated with the closing of six Bahama Breeze
restaurants and the write-down of the carrying value of four other Bahama Breeze
restaurants, one Olive Garden restaurant, and one Red Lobster restaurant, which
continued to operate. We also recorded a restructuring charge of $1,112
primarily related to severance payments made to certain restaurant employees and
exit costs associated with the closing of the six Bahama Breeze restaurants in
accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities". Below is a summary of the restructuring costs and the
remaining liability for fiscal 2004:
Balance at Balance at
May 25, 2003 Additions Utilizations May 30, 2004
- --------------------------------------------------------------------------------
One-time termination benefits $ -- $ 433 $ (384) $ 49
Lease termination costs -- 113 (113) --
Other exit costs -- 566 (255) 311
- --------------------------------------------------------------------------------
$ -- $1,112 $ (752) $ 360
================================================================================
Asset impairment charges related to the decision to relocate or rebuild certain
restaurants amounted to $5,667 and $4,876 in fiscal 2004 and 2003, respectively.
Asset impairment credits related to assets sold that were previously impaired
amounted to $1,437 and $594 in fiscal 2004 and 2003, respectively. All
impairment amounts are included in asset impairment and restructuring charges
(credits) in the consolidated statements of earnings.
During fiscal 2003 and fiscal 2002, we recognized restructuring credits of $358
and $2,568, respectively, resulting from lease terminations completed on more
favorable terms than previously anticipated from our fiscal 1997 restructuring
action. All restaurant closings and other activities under this restructuring
action were completed as of May 25, 2003.
NOTE 4 - LAND, BUILDINGS, AND EQUIPMENT
The components of land, buildings, and equipment are as follows:
May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------
Land $ 545,191 $ 505,444
Buildings 2,138,376 1,898,716
Equipment 1,008,133 922,592
Construction in progress 87,655 195,078
-------------------------------------------------------------------------------
Total land, buildings, and equipment 3,779,355 3,521,830
Less accumulated depreciation (1,528,739) (1,364,698)
-------------------------------------------------------------------------------
Net land, buildings, and equipment $2,250,616 $2,157,132
===============================================================================
NOTE 5 - OTHER ASSETS
The components of other assets are as follows:
May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------
Prepaid pension costs $ 67,077 $ 68,873
Trust-owned life insurance 40,422 34,316
Capitalized software costs, net 32,328 34,055
Liquor licenses 22,201 21,219
Prepaid interest and loan costs 12,396 14,863
Miscellaneous 9,001 8,546
-------------------------------------------------------------------------------
Total other assets $183,425 $181,872
===============================================================================
NOTE 6 - SHORT-TERM DEBT
Short-term debt at May 30, 2004, and May 25, 2003 consisted of $14,500 and $0,
respectively, of unsecured commercial paper borrowings with original maturities
of one month or less. The debt bore an interest rate of 1.09 percent at May 30,
2004.
22
NOTE 7 - LONG-TERM DEBT
The components of long-term debt are as follows:
May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------
8.375% senior notes due September 2005 $ 150,000 $ 150,000
6.375% notes due February 2006 150,000 150,000
5.75% medium-term notes due March 2007 150,000 150,000
7.45% medium-term notes due April 2011 75,000 75,000
7.125% debentures due February 2016 100,000 100,000
ESOP loan with variable rate of interest (1.43% at
May 30, 2004) due December 2018 29,403 34,430
-------------------------------------------------------------------------------
Total long-term debt 654,403 659,430
Less issuance discount (1,054) (1,344)
-------------------------------------------------------------------------------
Total long-term debt less issuance discount 653,349 658,086
Less current portion -- --
-------------------------------------------------------------------------------
Long-term debt, excluding current portion $ 653,349 $ 658,086
===============================================================================
In July 2000, we registered $500,000 of debt securities with the Securities and
Exchange Commission (SEC) using a shelf registration process. Under this
process, we may offer, from time to time, up to an aggregate of $500,000 of debt
securities. In September 2000, we issued $150,000 of unsecured 8.375 percent
senior notes due in September 2005. The senior notes rank equally with all of
our other unsecured and unsubordinated debt and will be senior in right of
payment to any future subordinated debt we may issue. In April 2001, we issued
$75,000 of unsecured 7.45 percent medium-term notes due in April 2011. In March
2002, we issued $150,000 of unsecured 5.75 percent medium-term notes due in
March 2007. At May 30, 2004, our shelf registration provides for the issuance of
an additional $125,000 of unsecured debt securities.
In January 1996, we issued $150,000 of unsecured 6.375 percent notes due in
February 2006 and $100,000 of unsecured 7.125 percent debentures due in February
2016. Concurrent with the issuance of the notes and debentures, we terminated,
and settled for cash, interest-rate swap agreements with notional amounts
totaling $200,000, which hedged the movement of interest rates prior to the
issuance of the notes and debentures. The cash paid in terminating the
interest-rate swap agreements is being amortized to interest expense over the
life of the notes and debentures. The effective annual interest rate is 7.57
percent for the notes and 7.82 percent for the debentures, after consideration
of loan costs, issuance discounts, and interest-rate swap termination costs.
We also maintain a credit facility that expires in October 2008, with a
consortium of banks under which we can borrow up to $400,000. The credit
facility allows us to borrow at interest rates that vary based on a spread over
(i) LIBOR or (ii) a base rate that is the higher of the prime rate, or one-half
of one percent above the federal funds rate, at our option. The interest rate
spread over LIBOR is determined by our debt rating. The credit facility supports
our commercial paper borrowing program. We are required to pay a facility fee of
12.5 basis points per annum on the average daily amount of loan commitments by
the consortium. The amount of interest and the annual facility fee are subject
to change based on our maintenance of certain debt ratings and financial ratios,
such as maximum debt to capital ratios. Advances under the credit facility are
unsecured. At May 30, 2004, and May 25, 2003, no borrowings were outstanding
under this credit facility.
The aggregate maturities of long-term debt for each of the five fiscal years
subsequent to May 30, 2004, and thereafter are $0 in 2005, $300,000 in 2006,
$150,000 in 2007, $0 in 2008 and 2009, and $204,403 thereafter.
NOTE 8 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We use interest rate related derivative instruments to manage our exposure on
debt instruments, as well as commodities derivatives to manage our exposure to
commodity price fluctuations. 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. Market risk is the adverse effect
on the value of a financial instrument that results from a change in interest
rates or commodity prices. We minimize this market risk by establishing and
monitoring parameters that limit the types and degree of market risk that may be
undertaken.
23
Futures Contracts and Commodity Swaps
During fiscal 2004 and 2003, we entered into futures contracts and commodity
swaps to reduce the risk of natural gas and coffee price fluctuations. To the
extent these derivatives are effective in offsetting the variability of the
hedged cash flows, changes in the derivatives' fair value are not included in
current earnings but are reported as other comprehensive income. These changes
in fair value are subsequently reclassified into earnings when the natural gas
and coffee are purchased and used by us in our operations. Net gains (losses) of
$(439) and $941 related to these derivatives were recognized in earnings during
fiscal 2004 and 2003, respectively. The fair value of these contracts was a net
gain of $106 at May 30, 2004, and is expected to be reclassified from
accumulated other comprehensive income (loss) into food and beverage costs or
restaurant expenses during the next 12 months. To the extent these derivatives
are not effective, changes in their fair value are immediately recognized in
current earnings. Outstanding derivatives are included in other current assets
or other current liabilities.
At May 30, 2004, the maximum length of time over which we are hedging our
exposure to the variability in future natural gas cash flows is 12 months. At
May 30, 2004, we are not hedging our exposure to the variability in future
coffee cash flows. No gains or losses were reclassified into earnings during
fiscal 2004 or 2003 as a result of the discontinuance of natural gas and coffee
cash flow hedges.
Interest Rate Lock Agreement
During fiscal 2002, we entered into a treasury interest rate lock agreement
(treasury lock) to hedge the risk that the cost of a future issuance of
fixed-rate debt may be adversely affected by interest rate fluctuations. The
treasury lock, which had a $75,000 notional principal amount of indebtedness,
was used to hedge a portion of the interest payments associated with $150,000 of
debt subsequently issued in March 2002. The treasury lock was settled at the
time of the related debt issuance with a net gain of $267 being recognized in
other comprehensive income. The net gain on the treasury lock is being amortized
into earnings as an adjustment to interest expense over the same period in which
the related interest costs on the new debt issuance are being recognized in
earnings. Amortization of $53, $53, and $14 was recognized in earnings as an
adjustment to interest expense during fiscal 2004, 2003, and 2002, respectively.
It is expected that $53 of this gain will be recognized in earnings as an
adjustment to interest expense during the next 12 months.
Interest Rate Swaps
During fiscal 2004, we entered into interest rate swap agreements (swaps) to
hedge the risk of changes in interest rates on the cost of a future issuance of
fixed-rate debt. The swaps, which have a $75,000 notional principal amount of
indebtedness, will be used to hedge a portion of the interest payments
associated with a forecasted issuance of debt in fiscal 2006. To the extent the
swaps are effective in offsetting the variability of the hedged cash flows,
changes in the fair value of the swaps are not included in current earnings but
are reported as other comprehensive income. The accumulated gain or loss at the
swap settlement date will be amortized into earnings as an adjustment to
interest expense over the same period in which the related interest costs on the
new debt issuance are recognized in earnings. The fair value of the swaps at May
30, 2004 was a gain of $698 and is included in accumulated other comprehensive
income (loss) at May 30, 2004. No amounts were recognized in earnings during
fiscal 2004.
We had interest rate swaps with a notional amount of $200,000, which we used to
convert variable rates on our long-term debt to fixed rates effective May 30,
1995. We received the one-month commercial paper interest rate and paid
fixed-rate interest ranging from 7.51 percent to 7.89 percent. The interest rate
swaps were settled during January 1996 at a cost to us of $27,670. This cost is
being recognized as an adjustment to interest expense over the term of our
10-year, 6.375 percent notes and 20-year, 7.125 percent debentures (see Note 7).
NOTE 9 - FINANCIAL INSTRUMENTS
The fair values of cash equivalents, accounts receivable, accounts payable, and
short-term debt approximate their carrying amounts due to their short duration.
The carrying value and fair value of long-term debt at May 30, 2004, was
$653,349 and $700,383, respectively. The carrying value and fair value of
long-term debt at May 25, 2003, was $658,086 and $740,130, 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.
24
NOTE 10 - STOCKHOLDERS' EQUITY
Treasury Stock
Our Board of Directors has authorized us to repurchase up to 115.4 million
shares of our common stock. In fiscal 2004, 2003, and 2002, we purchased
treasury stock totaling $235,462, $213,311, and $208,578, respectively. At May
30, 2004, a total of 109.2 million shares have been repurchased under the
authorization. The repurchased common stock is reflected as a reduction of
stockholders' equity.
Stock Purchase/Loan Program
We have share ownership guidelines for our officers. To assist them in meeting
these guidelines, we implemented the 1998 Stock Purchase/Option Award Loan
Program (Loan Program) in conjunction with our Stock Option and Long-Term
Incentive Plan of 1995. The Loan Program provided loans to our officers and
awarded two options for every new share purchased, up to a maximum total share
value equal to a designated percentage of the officer's base compensation. Loans
are full recourse and interest bearing, with a maximum principal amount of 75
percent of the value of the stock purchased. The stock purchased is held on
deposit with us until the loan is repaid. The interest rate for loans under the
Loan Program is fixed and is equal to the applicable federal rate for mid-term
loans with semi-annual compounding for the month in which the loan originates.
Interest is payable on a weekly basis. Loan principal is payable in installments
with 25 percent, 25 percent, and 50 percent of the total loan due at the end of
the fifth, sixth, and seventh years of the loan. Effective July 30, 2002, and in
compliance with the Sarbanes-Oxley Act of 2002, we no longer issue new loans to
our executive-level officers under the Loan Program. We account for outstanding
officer notes receivable as a reduction of stockholders' equity.
Stockholders' Rights Plan
Under our amended Rights Agreement, each share of our common stock has
associated with it two-thirds of a right to purchase one-hundredth of a share of
our Series A Participating Cumulative Preferred Stock at a purchase price of
$62.50, subject to adjustment under certain circumstances to prevent dilution.
The number of rights associated with each share of our common stock reflects an
adjustment resulting from our three-for-two stock split in May 2002. The rights
are exercisable when, and are not transferable apart from our common stock
until, a person or group has acquired 20 percent or more, or makes a tender
offer for 20 percent or more, of our common stock. If the specified percentage
of our common stock is then acquired, each right will entitle the holder (other
than the acquiring company) to receive, upon exercise, common stock of either us
or the acquiring company having a value equal to two times the exercise price of
the right. The rights are redeemable by our Board of Directors under certain
circumstances and expire on May 24, 2005.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) are as follows:
May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------
Foreign currency translation adjustment $(9,960) $(10,354)
Unrealized gains on derivatives 587 382
Minimum pension liability adjustment (586) (517)
-------------------------------------------------------------------------------
Total accumulated other comprehensive income (loss) $(9,959) $(10,489)
===============================================================================
Reclassification adjustments associated with pre-tax net derivative income
(losses) realized in net earnings for fiscal 2004, 2003, and 2002 amounted to
$(386), $994, and ($262), respectively.
NOTE 11 - LEASES
An analysis of rent expense incurred under operating leases is as follows:
Fiscal Year
-------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------------------------
Restaurant minimum rent $56,462 $48,121 $43,113
Restaurant percentage rent 3,820 3,682 3,550
Restaurant equipment minimum rent 57 5,719 8,386
Restaurant rent averaging expense 300 (663) (518)
Transportation equipment 2,514 2,665 2,481
Office equipment 1,302 1,138 1,526
Office space 1,286 1,713 1,387
Warehouse space 315 303 237
-------------------------------------------------------------------------------
Total rent expense $66,056 $62,678 $60,162
===============================================================================
25
Minimum rental obligations are accounted for on a straight-line basis over the
term of the lease. Percentage rent expense is generally based on sales levels.
Many of our leases have renewal periods totaling five to 20 years, exercisable
at our option, and require payment of property taxes, insurance, and maintenance
costs in addition to the rent payments. The annual non-cancelable future lease
commitments for each of the five fiscal years subsequent to May 30, 2004, and
thereafter are: $62,070 in 2005, $57,348 in 2006, $50,870 in 2007, $43,651 in
2008, $36,358 in 2009, and $123,402 thereafter, for a cumulative total of
$373,699.
NOTE 12 - INTEREST, NET
The components of interest, net, are as follows:
Fiscal Year
-------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------------------------
Interest expense $47,710 $47,566 $41,493
Capitalized interest (3,500) (3,470) (3,653)
Interest income (551) (1,499) (1,255)
-------------------------------------------------------------------------------
Interest, net $43,659 $42,597 $36,585
===============================================================================
Capitalized interest was computed using our average borrowing rate. We paid
$39,661, $38,682, and $31,027, for interest (excluding amounts capitalized) in
fiscal 2004, 2003, and 2002, respectively.
NOTE 13 - INCOME TAXES
The components of earnings before income taxes and the provision for income
taxes thereon are as follows:
Fiscal Year
-------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------------------------
Earnings before income taxes:
U.S. $ 335,606 $ 345,496 $ 359,947
Canada 4,392 2,252 3,362
-------------------------------------------------------------------------------
Earnings before income taxes $ 339,998 $ 347,748 $ 363,309
-------------------------------------------------------------------------------
Income taxes:
Current:
Federal $ 75,121 $ 68,178 $ 88,063
State and local 13,663 11,396 14,582
Canada 131 24 133
-------------------------------------------------------------------------------
Total current $ 88,915 $ 79,598 $ 102,778
-------------------------------------------------------------------------------
Deferred (principally U.S.) 19,621 35,890 22,743
-------------------------------------------------------------------------------
Total income taxes $ 108,536 $ 115,488 $ 125,521
===============================================================================
During fiscal 2004, 2003, and 2002, we paid income taxes of $92,265, $65,398,
and $56,839, respectively.
The following table is a reconciliation of the U.S. statutory income tax rate to
the effective income tax rate included in the accompanying consolidated
statements of earnings:
Fiscal Year
-------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------------------------
U.S. statutory rate 35.0% 35.0% 35.0%
State and local income taxes,
net of federal tax benefits 3.2 3.0 3.1
Benefit of federal income tax credits (5.2) (4.5) (3.9)
Other, net (1.1) (0.3) 0.4
-------------------------------------------------------------------------------
Effective income tax rate 31.9% 33.2% 34.6%
===============================================================================
26
The tax effects of temporary differences that give rise to deferred tax assets
and liabilities are as follows:
May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------
Accrued liabilities $ 13,286 $ 12,616
Compensation and employee benefits 63,234 55,935
Asset disposition and restructuring liabilities 2,651 2,004
Other 2,918 2,638
-------------------------------------------------------------------------------
Gross deferred tax assets $ 82,089 $ 73,193
-------------------------------------------------------------------------------
Buildings and equipment (143,910) (116,148)
Prepaid pension costs (25,452) (25,987)
Prepaid interest (1,333) (1,454)
Deferred rent and interest income (15,432) (13,117)
Capitalized software and other assets (15,976) (16,115)
Other (944) (1,703)
-------------------------------------------------------------------------------
Gross deferred tax liabilities $ (203,047) $ (174,524)
-------------------------------------------------------------------------------
Net deferred tax liabilities $ (120,958) $ (101,331)
===============================================================================
A valuation allowance for deferred tax assets is provided when it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. Realization is dependent upon the generation of future taxable income
or the reversal of deferred tax liabilities during the periods in which those
temporary differences become deductible. We consider the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. At May 30, 2004, and May 25, 2003, no
valuation allowance has been recognized for deferred tax assets because we
believe that sufficient projected future taxable income will be generated to
fully utilize the benefits of these deductible amounts.
NOTE 14 - RETIREMENT PLANS
Defined Benefit Plans and Postretirement Benefit Plan
Substantially all of our employees are eligible to participate in a retirement
plan. We sponsor non-contributory defined benefit pension plans for our salaried
employees, in which benefits are based on various formulas that include years of
service and compensation factors, and for a group of hourly employees, in which
a fixed level of benefits is provided. Pension plan assets are primarily
invested in U.S., international, and private equities, long duration fixed
income securities, and real assets. Our policy is to fund, at a minimum, the
amount necessary on an actuarial basis to provide for benefits in accordance
with the requirements of the Employee Retirement Income Security Act of 1974, as
amended. We also sponsor a contributory postretirement benefit plan that
provides health care benefits to our salaried retirees. During fiscal 2004,
2003, and 2002, we funded the defined benefit pension plans in the amount of
$85, $20,063, and $41, respectively. We expect to contribute approximately $100
to our defined benefit pension plans during fiscal 2005. During fiscal 2004,
2003, and 2002, we funded the postretirement benefit plan in the amount of $172,
$140, and $123, respectively. We expect to contribute approximately $260 to our
postretirement benefit plan during fiscal 2005.
27
The following provides a reconciliation of the changes in the plan benefit
obligation, fair value of plan assets, and the funded status of the plans as of
February 28, 2004 and 2003:
Defined Benefit Plans Postretirement Benefit Plan
- --------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Change in Benefit Obligation:
Benefit obligation at beginning of period $129,636 $111,155 $ 14,809 $ 9,356
Service cost 4,516 3,732 626 388
Interest cost 7,076 7,088 919 648
Participant contributions -- -- 128 112
Benefits paid (5,553) (4,558) (299) (252)
Actuarial loss 8,014 12,219 702 4,557
- --------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of period $143,689 $129,636 $ 16,885 $ 14,809
====================================================================================================================
Change in Plan Assets:
Fair value at beginning of period $115,962 $109,574 $ -- $ --
Actual return on plan assets 34,759 (9,117) -- --
Employer contributions 85 20,063 172 140
Participant contributions -- -- 128 112
Benefits paid (5,554) (4,558) (300) (252)
- --------------------------------------------------------------------------------------------------------------------
Fair value at end of period $145,252 $115,962 $ -- $ --
====================================================================================================================
Reconciliation of the Plan's Funded Status:
Funded status at end of period $ 1,563 $(13,675) $ (16,885) $ (14,809)
Unrecognized prior service cost (479) (936) -- 29
Unrecognized actuarial loss 62,062 79,805 6,458 6,089
Contributions for March to May 22 19 77 35
- --------------------------------------------------------------------------------------------------------------------
Prepaid (accrued) benefit costs $ 63,168 $ 65,213 $ (10,350) $ (8,656)
====================================================================================================================
Components of the Consolidated Balance
Sheets:
Prepaid benefit costs $ 67,077 $ 68,873 $ -- $ --
Accrued benefit costs (4,859) (4,496) (10,350) (8,656)
Accumulated other comprehensive loss 950 836 -- --
- --------------------------------------------------------------------------------------------------------------------
Net asset (liability) recognized $ 63,168 $ 65,213 $ (10,350) $ (8,656)
====================================================================================================================
The accumulated benefit obligation for all pension plans was $135,950 and
$119,070 at May 30, 2004, and May 25, 2003, respectively. The accumulated
benefit obligation and fair value of plan assets for pension plans with
accumulated benefit obligations in excess of plan assets were $4,881 and $0,
respectively, at February 28, 2004, and $4,515 and $0, respectively, at February
28, 2003. The projected benefit obligation for pension plans with projected
benefit obligations in excess of plan assets approximated their accumulated
benefit obligation at February 28, 2004 and February 28, 2003.
28
The following table presents the weighted-average assumptions used to determine
benefit obligations and net expense:
Defined Benefit Plans Postretirement Benefit Plan
- --------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------
Weighted-average assumptions used to determine
benefit obligations at May 30 and May 25, (1)
Discount rate 6.00% 6.25% 6.00% 6.25%
Rate of future compensation increases 3.75% 3.75% N/A N/A
Weighted-average assumptions used to determine
net expense for fiscal years ended
May 30 and May 25, (2)
Discount rate 6.25% 7.00% 6.25% 7.00%
Expected long-term rate of return on plan assets 9.00% 10.40% N/A N/A
Rate of future compensation increases 3.75% 3.75% N/A N/A
==============================================================================================================
<FN>
(1) Determined as of the end of fiscal year
(2) Determined as of the beginning of fiscal year
</FN>
We set the discount rate assumption annually for each of the plans at their
valuation dates to reflect the yield of high-quality fixed-income debt
instruments, with lives that approximate the maturity of the plan benefits. The
expected long-term rate of return on plan assets and health care cost trend
rates are based upon several factors, including our historical assumptions
compared with actual results, an analysis of current market conditions, asset
allocations, and the views of leading financial advisers and economists. Our
target asset allocation is 35 percent U.S. equities, 30 percent high-quality,
long-duration fixed-income securities, 15 percent international equities, 10
percent real assets, and 10 percent private equities. We monitor our actual
asset allocation to ensure that it approximates our target allocation and
believe that our long-term asset allocation will continue to approximate our
target allocation. The defined benefit pension plans have the following asset
allocations at their measurement dates of February 28, 2004, and 2003,
respectively:
- --------------------------------------------------------------------------------
2004 2003
- --------------------------------------------------------------------------------
U.S. equities 38% 42%
High-quality, long-duration fixed-income securities 26% 23%
International equities 18% 17%
Real assets 12% 11%
Private equities 6% 7%
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Based on an analysis performed in fiscal 2003, we lowered our defined benefit
plans' expected long-term rate of return on plan assets for fiscal 2004 to 9.0
percent, a reduction from its previous level of 10.4 percent. Our historical
ten-year rate of return on plan assets, calculated using the geometric method
average of returns, is approximately 10.5 percent as of May 30, 2004.
The discount rate and expected return on plan assets assumptions have a
significant effect on amounts reported for defined benefit pension plans. A
quarter percentage point change in the defined benefit plans' discount rate and
the expected long-term rate of return on plan assets would increase or decrease
earnings before income taxes by $769 and $357, respectively.
The assumed health care cost trend rate increase in the per-capita charges for
benefits ranged from 11.0 percent to 12.0 percent for fiscal 2005, depending on
the medical service category. The rates gradually decrease to 5.0 percent
through fiscal 2010 and remain at that level thereafter.
The assumed health care cost trend rate has a significant effect on amounts
reported for retiree health care plans. A one-percentage-point variance in the
assumed health care cost trend rate would increase or decrease the total of the
service and interest cost components of net periodic postretirement benefit cost
by $341 and $267, respectively, and would increase or decrease the accumulated
postretirement benefit obligation by $3,572 and $2,805, respectively.
29
Components of net periodic benefit cost (income) are as follows:
Defined Benefit Plans Postretirement Benefit Plan
- ----------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Service cost $ 4,516 $ 3,732 $ 3,586 $ 626 $ 388 $ 291
Interest cost 7,076 7,088 7,145 919 648 500
Expected return on plan assets (12,821) (12,739) 12,416) -- -- --
Amortization of unrecognized transition asset -- -- (642) -- -- --
Amortization of unrecognized prior service cost (348) (348) (456) 29 18 18
Recognized net actuarial loss 3,710 1,924 1,104 334 46 --
- ----------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost (income) $ 2,133 $ (343) $ (1,679) $ 1,908 $ 1,100 $ 809
======================================================================================================================
On December 8, 2003, President Bush signed into law the Medicare Prescription
Drug Improvement and Modernization Act of 2003 (the Act). The Act introduces a
prescription drug benefit beginning in 2006 under Medicare (Medicare Part D) as
well as a federal subsidy to sponsors of retiree health care benefit plans that
provide a benefit that is at least actuarially equivalent to Medicare Part D. We
have elected to defer accounting for the effects of the Act until we are able to
determine whether the benefits provided under our postretirement benefit plan is
actuarially equivalent to Medicare Part D. Therefore, our postretirement benefit
obligation has not been remeasured for the effects of the Act. We do not believe
the impact of the Act will be material to our results of operations, financial
position, or cash flows.
Defined Contribution Plan
We have a defined contribution plan covering most employees age 21 and older. We
match contributions for participants with at least one year of service at up to
six percent of compensation, based on our performance. The match ranges from a
minimum of $0.25 to $1.20 for each dollar contributed by the participant. The
plan had net assets of $390,461 at May 30, 2004, and $334,319 at May 25, 2003.
Expense recognized in fiscal 2004, 2003, and 2002 was $2,666, $1,732, and
$1,593, respectively. Employees classified as "highly compensated" under the
Internal Revenue Code are not eligible to participate in this plan. Instead,
highly compensated employees are eligible to participate in a separate
non-qualified deferred compensation plan. This plan allows eligible employees to
defer the payment of all or part of their annual salary and bonus, and provides
for awards that approximate the matching contributions and other amounts that
participants would have received had they been eligible to participate in our
defined contribution and defined benefit plans. Amounts payable to highly
compensated employees under the non-qualified deferred compensation plan totaled
$88,569 and $69,653 at May 30, 2004, and May 25, 2003, respectively. These
amounts are included in other current liabilities.
The defined contribution plan includes an Employee Stock Ownership Plan (ESOP).
This ESOP originally borrowed $50,000 from third parties, with guarantees by us,
and borrowed $25,000 from us at a variable interest rate. The $50,000 third
party loan was refinanced in 1997 by a commercial bank's loan to us and a
corresponding loan from us to the ESOP. Compensation expense is recognized as
contributions are accrued. In addition to matching plan participant
contributions, our contributions to the plan are also made to pay certain
employee incentive bonuses. Fluctuations in our stock price impact the amount of
expense to be recognized. Contributions to the plan, plus the dividends
accumulated on allocated and unallocated shares held by the ESOP, are used to
pay principal, interest, and expenses of the plan. As loan payments are made,
common stock is allocated to ESOP participants. In fiscal 2004, 2003, and 2002,
the ESOP incurred interest expense of $473, $697, and $1,258, respectively, and
used dividends received of $454, $1,002, and $735, respectively, and
contributions received from us of $4,093, $4,266, and $5,166, respectively, to
pay principal and interest on our debt.
The ESOP shares we own are included in average common shares outstanding for
purposes of calculating net earnings per share. At May 30, 2004, the ESOP's debt
to us had a balance of $29,403 with a variable rate of interest of 1.43 percent;
$12,503 of the principal balance is due to be repaid no later than December
2007, with the remaining $16,900 due to be repaid no later than December 2014.
The number of our common shares within the ESOP at May 30, 2004, approximated
10,699,000 shares, representing 4,271,000 allocated shares, 6,000
committed-to-be-released shares, and 6,422,000 suspense shares.
NOTE 15 - STOCK PLANS
We maintain three active stock option and stock grant plans under which new
awards may still be issued: the Stock Option and Long-Term Incentive Plan of
1995 (1995 Plan); the 2002 Stock Incentive Plan (2002 Plan); and the Stock Plan
for Directors (Director Stock Plan). We also have two other stock option and
stock grant plans under which we no longer can make new awards, although awards
outstanding under the plans may still vest and be exercised in accordance with
their terms: the Restaurant Management and Employee Stock Plan of 2000 (2000
Plan); and the Stock Option and Long-Term Incentive Conversion Plan (Conversion
Plan). All of the plans are administered by the Compensation Committee of the
Board of Directors. The 1995 Plan provides for the issuance of
30
up to 33,300,000 common shares in connection with the granting of non-qualified
stock options, restricted stock, or restricted stock units (RSUs) to key
employees. Up to 2,250,000 shares may be granted under the plan as restricted
stock and RSUs. No new awards may be made under the 1995 Plan after September
30, 2004. The 2002 Plan provides for the issuance of up to 8,550,000 common
shares in connection with the granting of non-qualified stock options, incentive
stock options, stock appreciation rights, stock awards, restricted stock, or
RSUs to key employees and non-employee directors. Up to 1,700,000 shares may be
granted under the plan as restricted stock and RSUs. The Director Stock Plan
provides for the issuance of up to 375,000 common shares out of our treasury in
connection with the granting of non-qualified stock options and restricted stock
and RSUs to non-employee directors. The 2000 Plan provided for the issuance of
up to 5,400,000 shares of common stock out of our treasury as non-qualified
stock options, restricted stock, or RSUs. The Conversion Plan provided for the
issuance of stock options and other awards to our officers and employees in
connection with our spin-off from our former parent, General Mills, Inc., in
1995. As noted above, no new awards may be made under the 2000 Plan and
Conversion Plan, although awards outstanding under those plans may still vest
and be exercised in accordance with their terms. Under all of the plans, stock
options are granted at a price equal to the fair value of the shares at the date
of grant, for terms not exceeding ten years, and have various vesting periods at
the discretion of the Compensation Committee. Outstanding options generally vest
over one to four years. Restricted stock and RSUs granted under the 1995, 2000,
and 2002 Plans generally vest over periods ranging from three to five years and
no sooner than one year from the date of grant. The restricted period for
certain grants may be accelerated based on performance goals established by the
Compensation Committee.
We also maintain the Compensation Plan for Non-Employee Directors. This plan
provides that non-employee directors may elect to receive their annual retainer
and meeting fees in any combination of cash, deferred cash, or our common
shares, and authorizes the issuance of up to 105,981 common shares out of our
treasury for this purpose. The common shares issuable under the plan have an
aggregate fair value equal to the value of the foregone retainer and meeting
fees.
The per share weighted-average fair value of stock options granted during fiscal
2004, 2003, and 2002 was $6.83, $9.01, and $6.05, respectively.
Stock option activity during the periods indicated was as follows:
Weighted-Average Weighted-Average
Options Exercise Price Options Exercise Price
Exercisable Per Share Outstanding Per Share
-------------------------------------------------------------------------------------------------------------------
Balance at May 27, 2001 12,222,339 $ 7.62 26,132,288 $ 9.68
-------------------------------------------------------------------------------------------------------------------
Options granted 5,776,350 $ 17.36
Options exercised (4,310,327) $ 8.36
Options cancelled (675,776) $ 13.49
-------------------------------------------------------------------------------------------------------------------
Balance at May 26, 2002 12,152,538 $ 8.31 26,922,535 $ 11.44
-------------------------------------------------------------------------------------------------------------------
Options granted 4,200,086 $ 25.99
Options exercised (3,132,894) $ 9.23
Options cancelled (1,298,094) $ 16.86
-------------------------------------------------------------------------------------------------------------------
Balance at May 25, 2003 13,481,166 $ 9.59 26,691,633 $ 13.73
-------------------------------------------------------------------------------------------------------------------
Options granted 3,336,655 $ 20.36
Options exercised (3,463,615) $ 10.01
Options cancelled (911,036) $ 18.98
-------------------------------------------------------------------------------------------------------------------
Balance at May 30, 2004 14,380,195 $ 11.00 25,653,637 $ 14.91
-------------------------------------------------------------------------------------------------------------------
The following table provides information regarding exercisable and outstanding
options at May 30, 2004:
Weighted-
Weighted- Weighted- Average
Range of Average Average Remaining
Exercise Options Exercise Options Exercise Contractual
Price Per Share Exercisable Price Per Share Outstanding Price Per Share Life (Years)
-------------------------------------------------------------------------------------------------------------------
$ 4.00 - $10.00 5,150,315 $ 6.87 5,150,315 $ 6.87 1.9
$10.01 - $15.00 7,613,735 12.20 9,075,619 11.96 5.3
$15.01 - $20.00 1,268,145 17.00 6,744,078 17.77 7.8
Over $20.00 348,000 24.01 4,683,625 25.34 8.4
-------------------------------------------------------------------------------------------------------------------
14,380,195 $ 11.00 25,653,637 $ 14.91 5.8
===================================================================================================================
31
We granted restricted stock and RSUs during fiscal 2004, 2003, and 2002 totaling
513,305, 275,610, and 428,280 shares, respectively. The per share
weighted-average fair value of the awards granted in fiscal 2004, 2003, and 2002
was $19.45, $26.53, and $17.10, respectively. After giving consideration to
assumed forfeiture rates and subsequent forfeiture adjustments, compensation
expense recognized in net earnings for awards granted in fiscal 2004, 2003, and
2002 amounted to $4,198, $3,579, and $4,392, respectively.
NOTE 16 - EMPLOYEE STOCK PURCHASE PLAN
We maintain the Darden Restaurants Employee Stock Purchase Plan to provide
eligible employees who have completed one year of service (excluding senior
officers subject to Section 16(b) of the Securities Exchange Act of 1934) an
opportunity to purchase shares of our common stock, subject to certain
limitations. Under the plan, up to an aggregate of 2,100,000 shares are
available for purchase by employees at the lower of 85 percent of the fair
market value of our common stock as of the first or last trading days of each
quarterly participation period. During fiscal 2004, 2003, and 2002, employees
purchased shares of common stock under the plan totaling 319,299, 261,409, and
284,576, respectively. At May 30, 2004, an additional 459,157 shares were
available for issuance.
No compensation expense has been recognized for shares issued under the plan.
The impact of recognizing compensation expense for purchases made under the plan
in accordance with the fair value method specified in SFAS No. 123 is less than
$900 and has no impact on reported basic or diluted net earnings per share.
NOTE 17 - COMMITMENTS AND CONTINGENCIES
We make trade commitments in the course of our normal operations. At May 30,
2004, and May 25, 2003, we were contingently liable for approximately $242 and
$8,301, respectively, under outstanding trade letters of credit issued in
connection with purchase commitments. These letters of credit have terms of two
months or less and are used to collateralize our obligations to third parties
for the purchase of inventories.
As collateral for performance on contracts and as credit guarantees to banks and
insurers, we were contingently liable for guarantees of subsidiary obligations
under standby letters of credit. At May 30, 2004, and May 25, 2003, we had
$72,480 and $41,442, respectively, of standby letters of credit related to
workers' compensation and general liabilities accrued in our consolidated
financial statements. At May 30, 2004, and May 25, 2003, we had $15,896 and
$7,503, respectively, of standby letters of credit related to contractual
operating lease obligations and other payments. All standby letters of credit
are renewable annually. At May 30, 2004, and May 25, 2003, we had other
commercial commitments of $2,125 and $2,250, respectively.
At May 30, 2004, and May 25, 2003, we had $4,346 and $4,254, respectively, of
guarantees associated with third-party sublease or assignment obligations. 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 at May 30, 2004, and May 25, 2003 amounted to $3,131 and $2,935,
respectively. We did not accrue for the guarantees, as the likelihood of the
third parties defaulting on the sublease or assignment agreements was less than
probable. In the event of default by a third party, the indemnity and/or default
clauses in our sublease and 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 sublease or
assignment agreements, except to the extent that the sublease or assignment
allows us to repossess the building and personal property. These guarantees
expire over their respective lease terms, which range from fiscal 2005 through
fiscal 2012.
In March 2003 and March 2002, three of our current and former hourly restaurant
employees filed two purported class action lawsuits against us in California
Superior Court of Orange County alleging violations of California labor laws
with respect to providing meal and rest breaks. The lawsuits seek penalties
under Department of Labor rules providing a one hundred dollar penalty per
violation per employee, plus attorney's fees on behalf of the plaintiffs and
other purported class members. Discovery is currently underway in these matters.
One of the cases was removed to our mandatory arbitration program, although the
Court retained the authority to permit a sample of class-wide discovery. We are
prosecuting an appeal to cause the other case to be similarly removed to
arbitration. In September 2003, three former employees in Washington State filed
a similar purported class action in Washington State Superior Court in Spokane
County alleging violations of Washington labor laws with respect to providing
meal and rest breaks. The Court stayed the action, and ordered the plaintiffs
into our mandatory arbitration program; the plaintiffs have filed a motion for
reconsideration. We intend to vigorously defend our position in all of these
cases. Although the outcome of the cases cannot be ascertained at this time, we
do not believe that the disposition of these cases, either individually or in
the aggregate, would have a material adverse effect on our financial position,
results of operations, or liquidity.
32
We are subject to other private lawsuits, administrative proceedings, and claims
that arise in the ordinary course of our business. These matters typically
involve claims from guests, employees, and others related to operational issues
common to the restaurant industry. A number of these lawsuits, proceedings, and
claims may exist at any given time. We do not believe that the final disposition
of the lawsuits and claims in which we are currently involved will have a
material adverse effect on our financial position, results of operations, or
liquidity.
NOTE 18 - QUARTERLY DATA (UNAUDITED)
The following table summarizes unaudited quarterly data for fiscal 2004 and
2003:
Fiscal 2004 - Quarters Ended
-------------------------------------------------------------------------------------------------------------------
Aug. 24 Nov. 23 Feb. 22 May 30 (1) Total
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Sales $1,259,689 $1,142,543 $1,241,952 $1,359,171 $5,003,355
Earnings before income taxes 103,984 46,626 113,005 76,383 339,998
Net earnings 68,594 31,253 77,899 53,716 231,462
Net earnings per share:
Basic 0.42 0.19 0.47 0.34 1.42
Diluted 0.40 0.18 0.46 0.32 1.36
Dividends paid per share -- 0.04 -- 0.04 0.08
Stock price:
High 21.62 22.77 22.50 25.60 25.60
Low 17.80 18.25 18.48 21.40 17.80
===================================================================================================================
Fiscal 2003 - Quarters Ended
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Aug. 25 Nov. 24 Feb. 23 May 25 Total
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Sales $1,174,565 $1,071,531 $1,181,383 $1,227,492 $4,654,971
Earnings before income taxes 109,005 56,220 93,325 89,198 347,748
Net earnings 71,886 37,478 61,786 61,110 232,260
Net earnings per share:
Basic 0.42 0.22 0.36 0.36 1.36
Diluted 0.40 0.21 0.35 0.35 1.31
Dividends paid per share -- 0.04 -- 0.04 0.08
Stock price:
High 27.83 26.13 22.96 20.27 27.83
Low 19.17 17.96 16.46 16.70 16.46
===================================================================================================================
<FN>
(1) Earnings before income taxes includes asset impairment charges of $36,526
($22,372 after-tax) for long-lived asset impairments associated with the
closing of six Bahama Breeze restaurants and the write-down of the carrying
value of four other Bahama Breeze restaurants, one Olive Garden restaurant,
and one Red Lobster restaurant, which continued to operate. Earnings before
income taxes also includes charges of $1,112 ($681 after-tax) related to
severance payments made to certain restaurant employees and exit costs
associated with the closing of six Bahama Breeze restaurants.
</FN>
33
Five-Year Financial Summary
(In thousands, except per share data)
Fiscal Year Ended
---------------------------------------------------------------------------------------------------------------------
May 30, May 25, May 26, May 27, May 28,
Operating Results 2004(1) 2003 2002 2001 2000
---------------------------------------------------------------------------------------------------------------------
Sales $5,003,355 $4,654,971 $4,366,911 $3,992,419 $3,675,461
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Costs and expenses:
Cost of sales:
Food and beverage 1,526,875 1,449,162 1,384,481 1,302,926 1,199,709
Restaurant labor 1,601,258 1,485,046 1,373,416 1,261,837 1,181,156
Restaurant expenses 767,584 703,554 628,701 559,670 510,727
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Total cost of sales, excluding restaurant
depreciation and amortization (2) $3,895,717 $3,637,762 $3,386,598 $3,124,433 $2,891,592
Selling, general, and administrative 472,109 431,722 417,158 389,240 363,041
Depreciation and amortization 210,004 191,218 165,829 146,864 130,464
Interest, net 43,659 42,597 36,585 30,664 22,388
Asset impairment and restructuring charges
(credits), net 41,868 3,924 (2,568) -- (5,931)
---------------------------------------------------------------------------------------------------------------------
Total costs and expenses $4,663,357 $4,307,223 $4,003,602 $3,691,201 $3,401,554
---------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 339,998 347,748 363,309 301,218 273,907
Income taxes 108,536 115,488 125,521 104,218 97,202
---------------------------------------------------------------------------------------------------------------------
Net earnings $ 231,462 $ 232,260 $ 237,788 $ 197,000 $ 176,705
---------------------------------------------------------------------------------------------------------------------
Net earnings per share:
Basic $ 1.42 $ 1.36 $ 1.36 $ 1.10 $ 0.92
Diluted $ 1.36 $ 1.31 $ 1.30 $ 1.06 $ 0.89
---------------------------------------------------------------------------------------------------------------------
Average number of common shares
outstanding, net of shares held in
Treasury:
Basic 163,500 170,300 174,700 179,600 192,800
Diluted 169,700 177,400 183,500 185,600 197,800
=====================================================================================================================
Financial Position
Total assets $ 2,780,348 $2,664,633 $2,529,736 $ 2,216,534 $1,969,555
Land, buildings, and equipment 2,250,616 2,157,132 1,926,947 1,779,515 1,578,541
Working capital (deficit) (337,174) (314,280) (157,662) (226,116) (316,427)
Long-term debt 653,349 658,086 662,506 520,574 306,586
Stockholders' equity 1,245,770 1,196,191 1,128,877 1,033,318 958,602
Stockholders' equity per outstanding share 7.86 7.25 6.56 5.87 5.23
=====================================================================================================================
Other Statistics
Cash flow from operations $ 525,411 $ 508,635 $ 508,101 $ 420,570 $ 342,626
Capital expenditures 354,326 423,273 318,392 355,139 268,946
Dividends paid 12,984 13,501 9,225 9,458 10,134
Dividends paid per share 0.080 0.080 0.053 0.053 0.053
Advertising expense 210,989 200,020 184,163 177,998 165,590
Stock price:
High 25.60 27.83 29.767 19.660 15.375
Low 17.80 16.46 15.400 10.292 8.292
Close $ 22.50 $ 18.35 $ 25.030 $ 19.267 $ 12.583
Number of employees 141,300 140,700 133,200 128,900 122,300
Number of restaurants 1,325 1,271 1,211 1,168 1,139
=====================================================================================================================
<FN>
(1) Fiscal year 2004 consisted of 53 weeks while all other fiscal years
consisted of 52 weeks.
(2) Total cost of sales, excluding restaurant depreciation and amortization of
$195,486, $177,127, $155,837, $138,229, and $123,477, respectively.
</FN>
34