Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This discussion and analysis below for the Company 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 2005 fiscal year, which ended on May 29, 2005, and our
2003 fiscal year, which ended on May 25, 2003, each had 52 weeks. Our 2004
fiscal year, which ended on May 30, 2004, had 53 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 2005 and 2003 fiscal
years.
OVERVIEW OF OPERATIONS
Our business operates in the casual dining segment of the restaurant industry,
primarily in the United States. At May 29, 2005, we operated 1,381 Red Lobster,
Olive Garden, Bahama Breeze, Smokey Bones Barbeque & Grill and Seasons 52
restaurants in the United States and Canada and licensed 37 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 $5.28 billion in fiscal 2005 and $5.00 billion in fiscal 2004, a
5.5 percent increase. On a 52-week basis, after reducing fiscal 2004 sales by
the $90 million contributed by the additional 53rd operating week, our sales
increased 7.4 percent in fiscal 2005. Net earnings for fiscal 2005 were $291
million ($1.78 per diluted share) compared with net earnings for fiscal 2004 of
$227 million ($1.34 per diluted share). Net earnings for fiscal 2005 increased
27.9 percent and diluted net earnings per share increased 32.8 percent compared
to fiscal 2004. The net earnings increase in fiscal 2005 reflected Red Lobster's
substantial progress in some important areas. A primary driver was substantially
improved operations behind Red Lobster's new "simply great" operating
discipline, which allowed the brand to simultaneously improve both guest
satisfaction and operating efficiency. Red Lobster finished fiscal 2005 with
three consecutive quarters of U.S. same-restaurant sales and guest count growth,
and year-over-year operating profit growth. Olive Garden also delivered strong
performance in fiscal 2005. Driven by U.S. same-restaurant sales increases in
each quarter of fiscal 2005, which resulted in 43 consecutive quarters of
same-restaurant sales growth, Olive Garden had a double-digit operating profit
increase, record annual operating profit and record return on sales. Bahama
Breeze also contributed to net earnings growth in fiscal 2005 as a result of
operating improvements in a number of areas and the closing and write down of
underperforming restaurants in fiscal 2004. Smokey Bones' continued investment
in expansion, combined with high rib costs and the write down in the carrying
value of one restaurant, resulted in a modestly greater operating loss in fiscal
2005 than in fiscal 2004.
In fiscal 2006, we expect a net increase of between 55 to 65 restaurants. We
expect combined U.S. same-restaurant sales growth in fiscal 2006 of between two
percent and four percent at Red Lobster and Olive Garden. We also expect Bahama
Breeze to have minimal effect on consolidated net earnings growth in fiscal 2006
as we continue to invest in positioning the business for successful, renewed
growth. And, in fiscal 2006, we expect Smokey Bones to open 25 to 30 new
restaurants while implementing menu enhancements to broaden its appeal. As a
result, we anticipate approximately $0.04 to $0.06 per diluted share improvement
in Smokey Bones' impact on our consolidated net earnings. On a consolidated
basis, we anticipate low double-digit diluted net earnings per share growth in
fiscal 2006.
Our mission is to be the best in casual dining, now and for generations. We
believe we can achieve this goal by continuing to build on our historical
strength as a multi-brand casual dining company, which is grounded in our
commitment to combining the following:
o A strong culture that inspires and engages our people, with firmly
held values, a clear mission and a core purpose to nourish and delight
everyone we serve;
o Competitively superior leadership;
o Brand management excellence;
o Restaurant operating excellence; and
o Restaurant support excellence
1
From a financial perspective, we seek to increase profits by leveraging our
fixed and semi-fixed costs with sales from new restaurants and increased guest
traffic and sales at existing restaurants. To evaluate our operations and assess
our financial performance, we monitor a number of operating measures, with a
special focus on two key factors:
o Same-restaurant sales - which are a year-over-year comparison of each
period's sales volumes for restaurants that are open more than 16
months; and
o Restaurant operating margins - which are restaurant sales less
restaurant-level cost of sales (food and beverage costs, restaurant
labor and other restaurant expenses).
Increasing same-restaurant sales can increase restaurant operating margins
because these incremental sales provide better leverage of our fixed and
semi-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 operating company, we gather daily sales data
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 same-restaurant guest counts as an indication of the long-term health of
an operating company, while increases in average check and menu mix may
contribute more significantly to near-term profitability. We continually focus
on balancing our pricing and product offerings with other initiatives to
generate sustainable same-restaurant sales growth.
We compute same-restaurant sales using restaurants open at least 16 months
because new restaurants experience an adjustment period before sales levels and
operating margins normalize. 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
intensely competitive and sensitive to economic cycles and other business
factors, including changes in consumer tastes and dietary habits. Other risks
and uncertainties include the price and availability of food, ingredients and
utilities; labor and insurance costs; higher-than-anticipated costs to open or
close restaurants; litigation; unfavorable publicity relating to food safety or
other concerns; lack of suitable locations; government regulations; and factors
that could impact our growth objectives, including the construction cost
increases, construction delays and other factors.
2
RESULTS OF OPERATIONS FOR FISCAL 2005, 2004 AND 2003
The following table sets forth selected operating data as a percentage of sales
for the 52-week periods ended May 29, 2005 and May 25, 2003 and the 53-week
period ended May 30, 2004. All information is derived from the consolidated
statements of earnings for the periods indicated.
Fiscal Years
------------------------------------------------------------------------------------------------------------------
2005 2004 2003
------------------------------------------------------------------------------------------------------------------
Sales......................................................... 100.0% 100.0% 100.0%
Costs and expenses:
Cost of sales:
Food and beverage........................................ 30.2 30.5 31.1
Restaurant labor......................................... 32.1 32.0 31.9
Restaurant expenses...................................... 15.3 15.5 15.3
------ ------ ------
Total cost of sales, excluding restaurant depreciation
and amortization of 3.8%, 3.9% and 3.8%, 77.6% 78.0% 78.3%
respectively........................................
Selling, general and administrative........................ 9.5 9.4 9.3
Depreciation and amortization.............................. 4.0 4.2 4.1
Interest, net.............................................. 0.8 0.9 0.9
Asset impairment and restructuring charges, net............ 0.1 0.9 0.1
------ ------ ------
Total costs and expenses......................... 92.0% 93.4% 92.7%
------ ------ ------
Earnings before income taxes.................................. 8.0 6.6 7.3
Income taxes.................................................. 2.5 2.1 2.4
------ ------ ------
Net earnings.................................................. 5.5% 4.5% 4.9%
====== ====== ======
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SALES
Sales were $5.28 billion in fiscal 2005, $5.00 billion in fiscal 2004 and $4.65
billion in fiscal 2003. The 5.5 percent increase in company-wide sales for
fiscal 2005 was primarily due to a net increase of 56 company-owned restaurants
compared to fiscal 2004 and same-restaurant sales increases at Olive Garden.
These sales increases were partially offset by the additional operating week in
fiscal 2004. After reducing fiscal 2004 sales by the $90 million contributed by
the additional operating week, sales would have been $4.91 billion for fiscal
2004 on a 52-week basis, resulting in a 7.4 percent increase in fiscal 2005.
Red Lobster sales were $2.44 billion in both fiscal 2005 and fiscal 2004. U.S.
same-restaurant sales for Red Lobster increased 0.9 percent (on a 52-week basis)
due to a 1.9 percent increase in average check offset partially by a 1.0 percent
decrease in same-restaurant guest counts. Average annual sales per restaurant
for Red Lobster were $3.6 million in fiscal 2005.
Olive Garden sales of $2.40 billion were 8.5 percent above last year. U.S.
same-restaurant sales for Olive Garden increased 7.2 percent (on a 52-week
basis) due to a 5.3 percent increase in same-restaurant guest counts and a 1.9
percent increase in average check. Average annual sales per restaurant for Olive
Garden were $4.4 million in fiscal 2005. Olive Garden has enjoyed 43 consecutive
quarters of U.S. same-restaurant sales increases.
Bahama Breeze sales of $164 million were 7.2 percent below last year.
Same-restaurant sales for Bahama Breeze decreased 1.6 percent (on a 52-week
basis) for fiscal 2005. Bahama Breeze also had six fewer restaurants in
operation during fiscal 2005. Average annual sales per restaurant for Bahama
Breeze were $5.1 million in fiscal 2005.
Smokey Bones sales of $269 million were 54.6 percent above last year.
Same-restaurant sales for Smokey Bones increased 1.1 percent (on a 52-week
basis) for fiscal 2005. Average annual sales per restaurant were $3.1 million,
with appreciable variation by region. Smokey Bones opened 35 new restaurants
during fiscal 2005.
3
The 7.5 percent increase in company-wide sales for fiscal 2004 versus fiscal
2003 was primarily due to a net increase of 54 company-owned restaurants
compared to fiscal 2003, same-restaurant sales increases at Olive Garden and the
additional operating week in fiscal 2004. After reducing fiscal 2004 sales by
the $90 million contributed by the additional operating week, total sales
increased 5.5 percent from fiscal 2003. These sales increases were partially
offset by decreased U.S. same-restaurant sales at Red Lobster. While Red
Lobster's sales of $2.44 billion were 0.1 percent above fiscal 2003, its U.S.
same-restaurant sales decreased 3.5 percent (on a 52-week basis) due to a 6.5
percent decrease in same-restaurant guest counts, partially offset by a 3.0
percent 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 fiscal 2003. U.S. same-restaurant
sales for Olive Garden increased 4.6 percent (on a 52-week basis) 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). Bahama Breeze sales of $176 million
were 28 percent above fiscal 2003. 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 higher in fiscal 2004 than in fiscal 2003, its average
annual sales per restaurant were $3.2 million (on a 52-week basis) and it opened
30 new restaurants during fiscal 2004.
COSTS AND EXPENSES
Total costs and expenses were $4.85 billion in fiscal 2005, $4.67 billion in
fiscal 2004 and $4.32 billion in fiscal 2003. Total costs and expenses in fiscal
2005 were 92.0 percent of sales, a decrease from 93.4 percent of sales in fiscal
2004 and 92.7 percent of sales in fiscal 2003.
Food and beverage costs increased $67 million, or 4.4 percent, from $1.53
billion to $1.59 billion in fiscal 2005 compared to fiscal 2004. 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. As a percent of sales,
food and beverage costs decreased from the prior year in fiscal 2005 primarily
as a result of favorable changes in promotional and menu mix of sales and
pricing changes, which were partially offset by higher dairy, beef, chicken and
seafood costs. As a percent of sales, food and beverage costs decreased from the
prior year in fiscal 2004 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 in fiscal 2004.
Restaurant labor increased $95 million, or 5.9 percent, from $1.60 billion to
$1.70 billion in fiscal 2005 compared to fiscal 2004. Restaurant labor increased
$116 million, or 7.8 percent, from $1.49 billion to $1.60 billion in fiscal 2004
compared to fiscal 2003. As a percent of sales, restaurant labor increased in
fiscal 2005 primarily as a result of a modest increase in wage rates and higher
manager bonuses at Olive Garden and Red Lobster as a result of their increased
operating performance in fiscal 2005. These factors were only partially offset
by the favorable impact of higher sales volumes. As a percent of sales,
restaurant labor increased in fiscal 2004 from fiscal 2003 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 its 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.
Restaurant expenses (which include lease, property tax, credit card, utility,
workers' compensation, insurance, new restaurant pre-opening and other
restaurant-level operating expenses) increased $31 million, or 4.1 percent, from
$775 million to $806 million in fiscal 2005 compared to fiscal 2004. Restaurant
expenses increased $61 million, or 8.6 percent, from $714 million to $775
million in fiscal 2004 compared to fiscal 2003. As a percent of sales,
restaurant expenses decreased in fiscal 2005 primarily due to decreased
insurance, workers' compensation and new restaurant pre-opening costs, which
were partially offset by increased utility expenses and repairs and maintenance
expenses. Restaurant expenses were also favorably impacted by higher sales
volumes. As a percent of sales, restaurant expenses increased in fiscal 2004
from 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 in fiscal 2004.
Selling, general and administrative expenses increased $25 million, or 5.4
percent, from $472 million to $497 million in fiscal 2005 compared to fiscal
2004. Selling, general and administrative expenses increased $40 million,
4
or 9.4 percent, from $432 million to $472 million in fiscal 2004 compared to
fiscal 2003. As a percent of sales, selling, general and administrative expenses
increased in fiscal 2005 primarily as a result of increased bonus costs, which
were partially offset by decreased marketing expenses as a percent of sales and
the favorable impact of higher sales volumes. As a percent of sales, selling,
general and administrative expenses increased in fiscal 2004 from fiscal 2003
primarily due to increased employee benefit costs, an increased contribution 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.
Depreciation and amortization expense increased $3 million, or 1.5 percent, from
$210 million to $213 million in fiscal 2005 compared to fiscal 2004.
Depreciation and amortization expense increased $19 million, or 9.8 percent,
from $191 million to $210 million in fiscal 2004 compared to fiscal 2003. As a
percent of sales, depreciation and amortization decreased in fiscal 2005
primarily as a result of the continued use of fully depreciated, well
maintained, equipment and the favorable impact of higher sales volumes, which
were only partially offset by new restaurant and remodel activities. This
benefit was only partially offset by increased repairs and maintenance costs
incurred in fiscal 2005. As a percent of sales, depreciation and amortization
increased in fiscal 2004 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 decreased $1 million, or 1.2 percent, from $44 million to
$43 million in fiscal 2005 compared to fiscal 2004. Net interest expense
increased $1 million, or 2.5 percent, from $43 million to $44 million in fiscal
2004 compared to fiscal 2003. As a percent of sales, net interest expense
decreased in fiscal 2005 primarily as a result of higher interest income in
fiscal 2005 and the favorable impact of higher sales volumes. 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.
During fiscal 2005, 2004 and 2003, we recognized asset impairment charges in the
amount of $1 million, $6 million and $5 million, 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 $3
million, $1 million and $1 million in fiscal 2005, 2004 and 2003, respectively.
During fiscal 2005, we also recorded charges of $6 million for the write-down of
carrying value of two Olive Garden restaurants, one Red Lobster restaurant and
one Smokey Bones restaurant. The Smokey Bones restaurant was closed subsequent
to fiscal 2005 while the two Olive Gardens and one Red Lobster continued to
operate.
In addition to the asset impairment charges described above, during the fourth
quarter of fiscal 2004, 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 the restaurant's 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
reduce 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.
INCOME TAXES
The effective income tax rates for fiscal 2005, 2004 and 2003 were 31.4 percent,
31.7 percent and 33.1 percent, respectively. The rate decrease in fiscal 2005
and fiscal 2004 was primarily a result of favorable resolutions of prior year
tax matters and an increase in FICA tax credits for employee-reported tips.
5
NET EARNINGS AND NET EARNINGS PER SHARE
Net earnings for fiscal 2005 were $291 million ($1.78 per diluted share)
compared with net earnings for fiscal 2004 of $227 million ($1.34 per diluted
share) and net earnings for fiscal 2003 of $226 million ($1.27 per diluted
share).
Net earnings for fiscal 2005 increased 27.9 percent and diluted net earnings per
share increased 32.8 percent compared to fiscal 2004. The increase in net
earnings and diluted net earnings per share were primarily due to decreases in
food and beverage costs, restaurant expenses and depreciation and amortization
expenses as a percent of sales, which were only partially offset by increases in
restaurant labor expenses and selling, general and administrative expenses as a
percent of sales. Fiscal 2004 net earnings were also impacted by the $38 million
pre-tax ($23 million after-tax) asset impairment and restructuring charges
recognized related to the closing of six Bahama Breeze restaurants and the write
down of another four Bahama Breeze restaurants, one Olive Garden restaurant and
one Red Lobster restaurant. The increase in diluted net earnings per share was
also due to a reduction in the average diluted shares outstanding from fiscal
2004 to fiscal 2005 primarily as a result of our continuing repurchase of our
common stock.
Net earnings for fiscal 2004 increased 0.5 percent and diluted net earnings per
share increased 5.5 percent compared to fiscal 2003. The increase in net
earnings was primarily due to decreases in food and beverage costs as a percent
of sales, which were largely offset by increases in restaurant labor, restaurant
expenses, selling, general and administrative expenses and depreciation and
amortization expense as a percent of sales and the 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. The
increase in diluted net earnings per share is primarily due to a reduction in
the average diluted shares outstanding from fiscal 2003 to fiscal 2004 primarily
as a result of our continuing repurchase of our common stock.
SEASONALITY
Our sales volumes fluctuate seasonally. During fiscal 2005, our sales were
highest in the spring and winter, followed by the summer, and lowest in the
fall. During fiscal 2004 and 2003, 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 2005, 2004 and 2003. 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 U.S.
generally accepted accounting principles. The preparation of these financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of sales and 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.
6
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 expected lease
term, including cancelable option periods, 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, the determination of what constitutes expected lease term 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.
Leases
We are obligated under various lease agreements for certain restaurants. We
recognize rent expense on a straight-line basis over the expected lease term,
including cancelable option periods as described below. Within the provisions of
certain of our leases, there are rent holidays and/or escalations in payments
over the base lease term, as well as renewal periods. The effects of the
holidays and escalations have been reflected in rent expense on a straight-line
basis over the expected lease term, which includes cancelable option periods
when it is deemed to be reasonably assured that we would incur an economic
penalty for not exercising the option. The lease term commences on the date when
we have the right to control the use of the leased property, which is typically
before rent payments are due under the terms of the lease. 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 consolidated financial statements reflect the same
lease term for amortizing leasehold improvements as we use to determine capital
versus operating lease classifications and in calculating straight-line rent
expense for each restaurant. Percentage rent expense is generally based upon
sales levels and is accrued at the point in time we determine that it is
probable that such sales levels will be achieved.
Our judgments related to the probable term for each restaurant affect the
classification and accounting for leases as capital versus operating, the rent
holidays and escalation in payments that are included in the calculation of
straight-line rent and the term over which leasehold improvements for each
restaurant facility are amortized. These judgments may produce materially
different amounts of depreciation, amortization and rent expense than would be
reported if different assumed lease terms were used.
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 amount of impairment
recognized is the amount by which the carrying amount of the assets exceeds
their fair value. Fair value is generally determined by 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 sale when certain criteria are met.
These criteria include the requirement that the likelihood of disposing of these
assets within one year is probable. Assets whose disposal is not probable within
one year remain in land, buildings and equipment until their disposal is
probable within one year.
7
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 the fourth
quarter of fiscal 2004, we recognized asset impairment charges of $37 million
($23 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.
During fiscal 2005, we recognized asset impairment charges of $6 million ($4
million after-tax) for the write-down of two Olive Garden restaurants, one Red
Lobster restaurant and one Smokey Bones restaurant based on an evaluation of
expected cash flows. The Smokey Bones restaurant was closed subsequent to fiscal
2005 while the two Olive Garden restaurants and one Red Lobster restaurant
continued to operate.
Insurance Accruals
Through the use of insurance program deductibles and self-insurance, we retain a
significant portion of expected losses under our workers' compensation, employee
medical and general liability programs. However, we carry insurance for
individual claims that generally exceed $0.25 million for workers' compensation
and general liability claims. Accrued liabilities have been recorded based on
our estimates of the anticipated ultimate costs to settle all claims, both
reported and not yet reported.
Our accounting policies regarding these 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, which we use to finance the purchases of land, buildings
and equipment and to repurchase shares of our common stock. 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 is our primary source of short-term financing. At
May 29, 2005, there were no borrowings 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
8
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," as defined in the
Credit Agreement. None of these covenants are expected to impact our liquidity
or capital resources. At May 29, 2005, we were in compliance with all covenants
under the Credit Agreement.
At May 29, 2005, our long-term debt consisted principally of: (1) $150 million
of unsecured 5.75 percent medium-term notes due in March 2007, (2) $75 million
of unsecured 7.45 percent medium-term notes due in April 2011, (3) $100 million
of unsecured 7.125 percent debentures due in February 2016 and (4) an unsecured,
variable rate $27 million commercial bank loan due in December 2018 that is used
to support two loans from us to the Employee Stock Ownership Plan portion of the
Darden Savings Plan. We also have $150 million of unsecured 8.375 percent senior
notes due in September 2005 and $150 million of unsecured 6.375 percent notes
due in February 2006 included in current liabilities, which we plan to repay
through the issuance of unsecured debt securities in fiscal 2006. 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 29,
2005, is as follows (in thousands):
- ---------------------------- -----------------------------------------------------------------------------------------
Payments Due by Period
- ---------------------------- -----------------------------------------------------------------------------------------
Contractual Less than 1-3 3-5 More than 5
Obligations Total 1 Year Years Years Years
- ---------------------------- ---------------- ----------------- ------------------ ----------------- -----------------
Long-term debt (1) $ 799,260 $338,025 $185,396 $ 26,163 $249,676
- ---------------------------- ---------------- ----------------- ------------------ ----------------- -----------------
Operating leases 419,543 68,301 119,710 88,464 143,068
- ---------------------------- ---------------- ----------------- ------------------ ----------------- -----------------
Purchase obligations(2) 579,008 562,930 14,492 1,586 --
- ---------------------------- ---------------- ----------------- ------------------ ----------------- -----------------
Benefit obligations (3) 160,178 13,407 28,061 30,345 88,365
- ---------------------------- ---------------- ----------------- ------------------ ----------------- -----------------
Total contractual
obligations $1,957,989 $982,663 $347,659 $146,558 $481,109
- ---------------------------- ---------------- ----------------- ------------------ ----------------- -----------------
- -------------------------- -------------------------------------------------------------------------------------------
Amount of Commitment Expiration per Period
- -------------------------- -------------------------------------------------------------------------------------------
Total Amounts
Other Commercial Committed Less than 1-3 3-5 More than 5
Commitments 1 Year Years Years Years
- -------------------------- --------------- ------------------ ------------------ ----------------- -------------------
Standby letters of
credit (4) $86,506 $86,506 $ -- $ -- $ --
- -------------------------- --------------- ------------------ ------------------ ----------------- -------------------
Guarantees (5) 1,768 499 719 345 205
- -------------------------- --------------- ------------------ ------------------ ----------------- -------------------
Total commercial
commitments $88,274 $87,005 $719 $345 $205
- -------------------------- --------------- ------------------ ------------------ ----------------- -------------------
<FN>
1) Includes interest payments associated with existing long-term debt,
including the current portion. Variable-rate interest payments associated
with the ESOP loan were estimated based on the interest rate in effect at
May 29, 2005 (3.42 percent). Excludes issuance discount of $763.
2) Includes commitments for food and beverage items and supplies, capital
projects and other miscellaneous commitments.
3) Includes expected payments associated with our defined benefit plans,
postretirement benefit plan and our non-qualified deferred compensation
plan through fiscal 2015.
4) Includes letters of credit for $72,677 of workers' compensation and general
liabilities accrued in our consolidated financial statements; also includes
letters of credit for $4,495 of lease payments included in contractual
operating lease obligation payments noted above.
5) Consists solely of guarantees associated with leased properties that have
been assigned to third parties. We are not aware of any non-performance
under these arrangements that would result in us having to perform in
accordance with the terms of the guarantees.
</FN>
9
As disclosed in Exhibit 12 to this 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 6.8 times and 5.7 times for the fiscal years ended
May 29, 2005 and May 30, 2004, respectively. Our adjusted debt to adjusted total
capital ratio (which includes 6.25 times the total annual restaurant minimum
rent ($62.1 million and $56.5 million for the fiscal years ended May 29, 2005
and May 30, 2004, respectively) and 3.00 times the total annual restaurant
equipment minimum rent ($0.0 million and $0.1 million for the fiscal years ended
May 29, 2005 and May 30, 2004, respectively) as components of adjusted debt and
adjusted total capital) was 45 percent and 46 percent at May 29, 2005 and May
30, 2004, respectively. 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.
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 29, 2005 May 30, 2004
-------------------------------------------------------------------------------
CAPITAL STRUCTURE
-------------------------------------------------------------------------------
Short-term debt $ -- $ 15
Current portion of long-term debt 300 --
Long-term debt 350 653
Stockholders' equity 1,273 1,175
-------------------------------------------------------------------------------
Total capital $ 1,923 $ 1,843
===============================================================================
ADJUSTMENTS TO CAPITAL
-------------------------------------------------------------------------------
Short-term debt $ -- $ 15
Current portion of long-term debt 300 --
Long-term debt 350 653
Lease-debt equivalent 385 353
-------------------------------------------------------------------------------
Adjusted debt $ 1,035 $ 1,021
Stockholders' equity 1,273 1,175
-------------------------------------------------------------------------------
Adjusted total capital $ 2,308 $ 2,196
===============================================================================
CAPITAL STRUCTURE RATIOS
-------------------------------------------------------------------------------
Debt to total capital ratio 34% 36%
Adjusted debt to adjusted total capital ratio 45% 46%
===============================================================================
Net cash flows provided by operating activities were $583 million, $525 million
and $509 million in fiscal 2005, 2004 and 2003, respectively. Net cash flows
provided by operating activities include net earnings of $291 million, $227
million and $226 million in fiscal 2005, 2004 and 2003, respectively. Fiscal
2004 net earnings included 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. Net cash flows provided by operating
activities also reflect income tax payments of $111 million, $92 million and $65
million in fiscal 2005, 2004 and 2003, respectively. The increase in tax
payments in fiscal 2005 and 2004 resulted primarily from accelerated deductions
allowable for depreciation of certain capital expenditures in fiscal 2004 and
2003, which lowered our income tax payments in those fiscal years. These
accelerated deductions were allowable for only a portion of fiscal 2005 capital
expenditures. In fiscal 2005, however, the impact of the reduction in
accelerated depreciation deductions was partially offset by an increase in
income tax benefits associated with the exercise of employee stock options.
Net cash flows used in financing activities were $264 million, $194 million and
$193 million in fiscal 2005, 2004 and 2003, respectively. Net cash flows used in
financing activities included our repurchase of 11.3 million shares of our
common stock for $312 million in fiscal 2005, compared to 10.7 million shares
for $235 million in fiscal 2004 and 10.7 million shares for $213 million in
fiscal 2003. Our Board of Directors has authorized us to repurchase up to 137.4
million shares of our common stock. At May 29, 2005 a total of 120.6 million
shares have been repurchased under the authorization. The repurchased common
stock is reflected as a reduction of stockholders' equity. We received proceeds
from the issuance of common stock upon the exercise of stock options of $75
million,
10
$40 million and $34 million in fiscal 2005, 2004 and 2003, respectively. Net
cash flows used in financing activities also included dividends paid to
stockholders of $13 million, $13 million and $14 million in fiscal 2005, 2004
and 2003, respectively.
Net cash flows used in investing activities were $313 million, $343 million and
$420 million in fiscal 2005, 2004 and 2003, 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 $329 million in fiscal 2005, compared to
$354 million in fiscal 2004 and $423 million in fiscal 2003. The decreased
expenditures in fiscal 2005 and 2004 resulted primarily from decreased spending
associated with building fewer new restaurants and fewer remodels. We estimate
that our fiscal 2006 capital expenditures will approximate $350 million to $375
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. Approximately $0.1 million was required to fund our
defined benefit pension plans in fiscal 2005 and fiscal 2004. 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 29, 2005, our discount rate was 5.75 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 29, 2005, our expected health care cost trend rates ranged from
11.0 percent to 12.0 percent for fiscal 2006, depending on the medical service
category. The rates gradually decrease to 5.0 percent through fiscal 2011 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
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 10.9
percent as of May 29, 2005.
We have an unrecognized net actuarial loss for the defined benefit plans and
postretirement benefit plan as of May 29, 2005 of $59 million and $4 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 2006 net periodic
benefit cost for the defined benefit plans and postretirement benefit plan is
expected to be approximately $5 million and $0.2 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 $0.7 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 increase the
accumulated postretirement benefit obligation (APBO) by $4 million at May 29,
2005 and the aggregate of the service cost and interest cost components of net
periodic postretirement benefit cost by $0.6 million for fiscal 2005. A one
percentage point decrease in the health care cost trend rates
11
would decrease the APBO by $3 million at May 29, 2005 and the aggregate of the
service cost and interest cost components of net periodic postretirement benefit
cost by $0.5 million for fiscal 2005. 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, debt maturities, stock repurchase program and
other operating activities through fiscal 2006.
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, sales or expenses, results of
operations, liquidity, capital expenditures or capital resources.
FINANCIAL CONDITION
Our total current assets were $407 million at May 29, 2005, compared to $346
million at May 30, 2004. The increase resulted primarily from increases in
inventories of $37 million that resulted from opportunistic product purchases
made during fiscal 2005.
Our total current liabilities were $1.04 billion at May 29, 2005, compared to
$0.68 billion at May 30, 2004. The increase in current liabilities is primarily
due to the reclassification of the $150 million of unsecured 8.375 percent
senior notes due in September 2005 and the $150 million of unsecured 6.375
percent notes due in February 2006 from long-term debt to current liabilities.
Accounts payable of $191 million at May 29, 2005 increased from $175 million,
primarily due to the timing of our inventory and capital expenditures at the end
of fiscal 2005. Other current liabilities of $254 million at May 29, 2005
increased from $228 million at May 30, 2004, primarily due to a $20 million
increase in liabilities associated with our non-qualified deferred compensation
plan.
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, compensation and commodity prices. To
manage this exposure, we periodically enter into interest rate, foreign currency
exchange, equity forwards and commodity instruments for other than trading
purposes (see Notes 1 and 9 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 29, 2005, 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 $6 million over a
period of one year (including the impact of the interest rate swap agreements
discussed in Note 9 of 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 $17 million. The fair
value of our long-term fixed rate debt during fiscal 2005 averaged $668 million,
with a high of $677 million and a low of $655 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.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
In December 2004, the FASB issued SFAS No. 123 (Revised), "Share-Based Payment."
SFAS No. 123R revises SFAS No. 123, "Accounting for Stock-Based Compensation"
and generally requires the cost associated with employee services received in
exchange for an award of equity instruments be measured based on the grant-date
fair value of the award and recognized in the financial statements over the
period during which employees are required to provide service in exchange for
the award. SFAS No. 123R also provides guidance on how to determine the
grant-date fair value for awards of equity instruments as well as alternative
methods of adopting its requirements. SFAS No. 123R is effective for annual
reporting periods beginning after June 15, 2005. As disclosed in Note 1 of Notes
to Consolidated Financial Statements, based on the current assumptions and
calculations used, had we recognized compensation expense based on the fair
value of awards of equity instruments, net earnings would have been reduced by
approximately $18 million, $15 million and $17 million for fiscal 2005, 2004 and
2003, respectively. We have
12
not yet determined the method of adoption or the effect of adopting SFAS No.
123R and have not determined whether the adoption will result in future amounts
similar to the current pro forma disclosures under SFAS No. 123.
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 the Private Securities Litigation Reform
Act of 1995, as codified in Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
Exchange Act). 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 and related capital expenditures; same-restaurant sales
growth; expected diluted net earnings per share growth; expected trends that
might impact capital requirements and liquidity; expected contributions to our
defined benefit pension plans; and the impact of litigation on our financial
position. 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 intensely competitive nature of the restaurant industry,
especially pricing, service, location, personnel and type and quality
of food;
o economic and business factors, both specific to the restaurant
industry and generally, including changes in consumer preferences,
demographic trends, weather conditions, a protracted economic slowdown
or worsening economy, industry-wide cost pressures and public safety
conditions, including actual or threatened armed conflicts or
terrorist attacks;
o the price and availability of food, ingredients and utilities,
including the general risk of inflation;
o labor and insurance costs, including increased labor costs as a result
of federal and state-mandated increases in minimum wage rates and
increased insurance costs as a result of increases in our current
insurance premiums;
o increased advertising and marketing costs;
o higher-than-anticipated costs to open, close, relocate or remodel
restaurants;
o litigation by employees, consumers, suppliers, shareholders or others,
regardless of whether the allegations made against us are valid or we
are ultimately found liable;
o unfavorable publicity relating to food safety or other concerns;
o a lack of suitable new restaurant locations or a decline in the
quality of the locations of our current restaurants;
o federal, state and local regulation of our business, including laws
and regulations relating to our relationships with our employees,
zoning, land use, environmental matters and liquor licenses; and
o growth objectives, including lower-than-expected sales and
profitability of newly-opened restaurants, our expansion of newer
concepts that have not yet proven their long-term viability, our
ability to develop new concepts, risks associated with growth through
acquisitions, and our ability to manage risks relating to the opening
of new restaurants, including real estate development and construction
activities, union activities, the issuance and renewal of licenses and
permits, the availability of funds to finance growth and our ability
to hire and train qualified personnel.
13
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 accounting principles generally
accepted in the United States of America, 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/ Clarence Otis, Jr.
Clarence Otis, Jr.
Chief Executive Officer
14
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act). The Company's internal control over financial reporting is
designed to provide reasonable assurance to the Company's management and Board
of Directors regarding the preparation and fair presentation of published
financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.
Management assessed the effectiveness of the Company's internal control over
financial reporting as of May 29, 2005. In making this assessment, our
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework. Management has concluded that, as of May 29, 2005, the Company's
internal control over financial reporting was effective based on these criteria.
The Company's independent registered public accounting firm, KPMG LLP, has
issued an audit report on our assessment of our internal control over financial
reporting, which follows.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER
FINANCIAL REPORTING
The Board of Directors and Stockholders
Darden Restaurants, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Darden
Restaurants, Inc. maintained effective internal control over financial reporting
as of May 29, 2005 based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Darden Restaurants, Inc.'s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
15
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Darden Restaurants, Inc. maintained
effective internal control over financial reporting as of May 29, 2005 is fairly
stated, in all material respects, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). Also, in our opinion, Darden Restaurants,
Inc. maintained, in all material respects, effective internal control over
financial reporting as of May 29, 2005, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Darden Restaurants, Inc. and subsidiaries as of May 29, 2005 and May 30, 2004,
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 29, 2005, and our report
dated July 28, 2005 expressed an unqualified opinion on those consolidated
financial statements.
/s/ KPMG LLP
Orlando, FL
July 28, 2005
16
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 29, 2005 and May 30, 2004, 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 29, 2005. 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 29, 2005 and May 30, 2004, and the results of
their operations and their cash flows for each of the years in the three-year
period ended May 29, 2005 in conformity with accounting principles generally
accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Darden
Restaurants, Inc.'s internal control over financial reporting as of May 29, 2005
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and
our report dated July 28, 2005 expressed an unqualified opinion on management's
assessment of, and the effective operation of, internal control over financial
reporting.
/s/ KPMG LLP
Orlando, Florida
July 28, 2005
17
CONSOLIDATED STATEMENTS OF EARNINGS
Fiscal Year Ended
-------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data) May 29, 2005 May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------------------------------------------
Sales $5,278,110 $5,003,355 $4,654,971
Costs and expenses:
Cost of sales:
Food and beverage 1,593,709 1,526,875 1,449,162
Restaurant labor 1,695,805 1,601,258 1,485,046
Restaurant expenses 806,314 774,806 713,699
-------------------------------------------------------------------------------------------------------------------
Total cost of sales, excluding restaurant
depreciation and amortization of $198,422,
$195,486 and $177,127, respectively $4,095,828 $3,902,939 $3,647,907
Selling, general and administrative 497,478 472,109 431,722
Depreciation and amortization 213,219 210,004 191,218
Interest, net 43,119 43,659 42,597
Asset impairment and restructuring charges, net 4,549 41,868 3,924
-------------------------------------------------------------------------------------------------------------------
Total costs and expenses $4,854,193 $4,670,579 $4,317,368
-------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 423,917 332,776 337,603
Income taxes 133,311 105,603 111,624
-------------------------------------------------------------------------------------------------------------------
Net earnings $ 290,606 $ 227,173 $ 225,979
===================================================================================================================
Net earnings per share:
Basic $ 1.85 $ 1.39 $ 1.33
Diluted $ 1.78 $ 1.34 $ 1.27
===================================================================================================================
Average number of common shares outstanding:
Basic 156,700 163,500 170,300
Diluted 163,400 169,700 177,400
===================================================================================================================
See accompanying notes to consolidated financial statements.
18
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------------------------------------------
(In thousands) May 29, 2005 May 30, 2004
-------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 42,801 $ 36,694
Receivables 36,510 30,258
Inventories 235,444 198,781
Prepaid expenses and other current assets 28,927 25,316
Deferred income taxes 63,584 55,258
-------------------------------------------------------------------------------------------------------------------
Total current assets $ 407,266 $ 346,307
Land, buildings and equipment, net 2,351,454 2,250,616
Other assets 179,051 183,425
-------------------------------------------------------------------------------------------------------------------
Total assets $ 2,937,771 $ 2,780,348
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 191,197 $ 174,624
Short-term debt -- 14,500
Accrued payroll 114,602 103,327
Accrued income taxes 52,404 48,753
Other accrued taxes 43,825 38,440
Unearned revenues 88,472 75,513
Current portion of long-term debt 299,929 --
Other current liabilities 254,178 228,324
-------------------------------------------------------------------------------------------------------------------
Total current liabilities $ 1,044,607 $ 683,481
Long-term debt, less current portion 350,318 653,349
Deferred income taxes 114,846 132,690
Deferred rent 130,872 122,879
Other liabilities 24,109 12,661
-------------------------------------------------------------------------------------------------------------------
Total liabilities $ 1,664,752 $ 1,605,060
-------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock and surplus, no par value. Authorized
500,000 shares; issued 271,102 and 264,907 shares,
respectively; outstanding 154,391 and 158,431 shares,
respectively $ 1,703,336 $ 1,584,115
Preferred stock, no par value. Authorized 25,000 shares;
none issued and outstanding -- --
Retained earnings 1,405,754 1,127,653
Treasury stock, 116,711 and 106,476 shares,
at cost, respectively (1,784,835) (1,483,768)
Accumulated other comprehensive income (loss) (8,876) (10,173)
Unearned compensation (41,685) (41,401)
Officer notes receivable (675) (1,138)
-------------------------------------------------------------------------------------------------------------------
Total stockholders' equity $ 1,273,019 $ 1,175,288
-------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 2,937,771 $ 2,780,348
===================================================================================================================
See accompanying notes to consolidated financial statements.
19
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
- --------------------------------------------------------------------------------------------------------------------------------
Common Accumulated Officer Total
Stock Other
and Retained Treasury Comprehensive Unearned Notes Stockholders'
(In thousands, except per share data) Surplus Earnings Stock Income (Loss) Compensation Receivable Equity
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 26, 2002 $1,474,054 $ 700,986 $(1,044,915) $(12,414) $(46,108) $(1,997) $1,069,606
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net earnings -- 225,979 -- -- -- -- 225,979
Other comprehensive income (loss):
Foreign currency adjustment -- -- -- 1,995 -- -- 1,995
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 227,747
Cash dividends declared ($0.08 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
Repayment of officer notes, net -- -- -- -- -- 418 418
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 25, 2003 $1,525,957 $ 913,464 $(1,254,293) $(10,646) $(42,848) $(1,579) $1,130,055
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net earnings -- 227,173 -- -- -- -- 227,173
Other comprehensive income (loss):
Foreign currency adjustment -- -- -- 337 -- -- 337
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 227,646
Cash dividends declared ($0.08 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
Repayment of officer notes -- -- -- -- -- 441 441
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 30, 2004 $1,584,115 $1,127,653 $(1,483,768) $(10,173) $(41,401) $(1,138) $1,175,288
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net earnings -- 290,606 -- -- -- -- 290,606
Other comprehensive income (loss):
Foreign currency adjustment -- -- -- 1,450 -- -- 1,450
Change in fair value of derivatives,
net of tax of $1,503 -- -- -- (243) -- -- (243)
Minimum pension liability
adjustment,net of tax benefit
of $56 -- -- -- 90 -- -- 90
--------
Total comprehensive income 291,903
Cash dividends declared ($0.08 per share) -- (12,505) -- -- -- -- (12,505)
Stock option exercises (6,615 shares) 62,464 -- 7,081 -- -- -- 69,545
Issuance of restricted stock (378 shares),
net of forfeiture adjustments 9,535 -- -- -- (9,535) -- --
Earned compensation -- -- -- -- 7,464 -- 7,464
ESOP note receivable repayments -- -- -- -- 3,393 -- 3,393
Income tax benefits credited to equity 42,996 -- -- -- -- -- 42,996
Purchases of common stock for treasury
(11,343 shares) -- -- (311,686) -- -- -- (311,686)
Issuance of treasury stock under Employee
Stock Purchase Plan and other plans
(296 shares) 4,226 -- 1,932 -- -- -- 6,158
Issuance of treasury stock under Employee
Stock Ownership Plan (50 shares) -- -- 1,606 -- (1,606) -- --
Repayment of officer notes -- -- -- -- -- 463 463
- --------------------------------------------------------------------------------------------------------------------------------
Balance at May 29, 2005 $1,703,336 $1,405,754 $(1,784,835) $ (8,876) $(41,685) $ (675) $1,273,019
================================================================================================================================
See accompanying notes to consolidated financial statements.
20
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended
-------------------------------------------------------------------------------------------------------------------
(In thousands) May 29, 2005 May 30, 2004 May 25, 2003
-------------------------------------------------------------------------------------------------------------------
Cash flows - operating activities
Net earnings $ 290,606 $ 227,173 $ 225,979
Adjustments to reconcile net earnings to cash flows:
Depreciation and amortization 213,219 210,004 191,218
Asset impairment charges, net 4,549 40,756 4,282
Restructuring charge (credit) -- 1,112 (358)
Amortization of unearned compensation and loan costs 11,041 7,599 6,901
Change in current assets and liabilities 28,967 2,207 36,046
Contribution to defined benefit pension plans and
postretirement plan (575) (257) (20,203)
Loss on disposal of land, buildings and equipment 1,164 104 2,456
Change in cash surrender value of trust-owned life
insurance (3,451) (6,106) 2,441
Deferred income taxes (24,722) 16,688 32,026
Change in deferred rent 7,993 7,583 10,098
Change in other liabilities 11,920 1,490 1,051
Income tax benefits credited to equity 42,996 15,650 16,385
Non-cash compensation expense 1,006 861 758
Other, net (1,471) 547 (445)
-------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 583,242 $ 525,411 $ 508,635
-------------------------------------------------------------------------------------------------------------------
Cash flows - investing activities
Purchases of land, buildings and equipment (329,238) (354,326) (423,273)
Increase in other assets (1,931) (5,128) (8,100)
Purchase of trust-owned life insurance -- -- (6,000)
Proceeds from disposal of land, buildings and equipment 18,028 16,197 7,641
Proceeds from maturities of short-term investments -- -- 10,000
-------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities $(313,141) $(343,257) $(419,732)
-------------------------------------------------------------------------------------------------------------------
Cash flows - financing activities
Proceeds from issuance of common stock 74,697 39,856 33,664
Dividends paid (12,505) (12,984) (13,501)
Purchases of treasury stock (311,686) (235,462) (213,311)
ESOP note receivable repayments 3,393 5,027 4,710
(Decrease) increase in short-term debt (14,500) 14,500 --
Repayment of long-term debt (3,393) (5,027) (4,710)
-------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities $(263,994) $(194,090) $(193,148)
-------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 6,107 (11,936) (104,245)
Cash and cash equivalents - beginning of year 36,694 48,630 152,875
-------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents - end of year $ 42,801 $ 36,694 $ 48,630
===================================================================================================================
Cash flows from changes in current assets and liabilities
Receivables (5,533) (279) 66
Inventories (36,663) (25,137) (1,231)
Prepaid expenses and other current assets (4,463) (190) (8,523)
Accounts payable 16,573 (1,027) 15,927
Accrued payroll 11,275 17,352 (1,961)
Accrued income taxes 3,651 (19,222) (529)
Other accrued taxes 5,385 3,371 4,595
Unearned revenues 12,959 2,815 16,066
Other current liabilities 25,783 24,524 11,636
-------------------------------------------------------------------------------------------------------------------
Change in current assets and liabilities $ 28,967 $ 2,207 $ 36,046
===================================================================================================================
See accompanying notes to consolidated financial statements.
21
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 37 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 2005 and 2003 both
consisted of 52 weeks of operation. Fiscal 2004 consisted of 53 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 consist of food and beverages, and 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. Repair and maintenance costs incurred to maintain the appearance
and functionality of the land, buildings and equipment that do not extend its
useful life or that are less than $1 are expensed as incurred. 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 expected lease term, including cancelable
option periods, 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 buildings and equipment amounted to
$206,552, $203,349 and $184,963, in fiscal 2005, 2004 and 2003, respectively. In
fiscal 2005, 2004 and 2003, we had losses on disposal of land, buildings and
equipment of $1,164, $104 and $2,456, 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 29, 2005 and May 30, 2004,
amounted to $51,292 and $46,629, respectively. Accumulated amortization as of
May 29, 2005 and May 30, 2004 amounted to $19,877 and $14,301, respectively.
Amortization expense associated with capitalized software amounted to $6,667,
$6,655 and $6,255, in fiscal 2005, 2004 and 2003, 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.
22
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 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. Assets whose disposal is not probable
within one year remain in land, buildings and equipment until their disposal is
probable within one year.
Insurance Accruals
Through the use of insurance program deductibles and self-insurance, we retain a
significant portion of expected losses under our workers' compensation, employee
medical and general liability programs. However, we carry insurance for
individual claims that generally exceed $250 for workers' compensation and
general liability claims. Accrued liabilities have been recorded based on our
estimates of the anticipated ultimate costs to settle all 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
more and payments received are initially recorded as long-term liabilities.
Amounts which are expected to be earned within one year are recorded as a
current liability.
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.
23
Derivative Instruments and Hedging Activities
We use financial and commodities derivatives to manage interest rate,
compensation and commodities pricing risks inherent in our business operations.
Our use of derivative instruments is currently limited to interest rate hedges,
equity forwards contracts 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.
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.
Operating Leases
We recognize rent expense on a straight-line basis over the expected lease term,
including cancelable option periods when it is deemed to be reasonably assured
that we would incur an economic penalty for not exercising the options. Within
the provisions of certain of our leases, there are rent holidays and/or
escalations in payments over the base lease term, as well as renewal periods.
The effects of the holidays and escalations have been reflected in rent expense
on a straight-line basis over the expected lease term, which includes cancelable
option periods when it is deemed to be reasonably assured that we would incur an
economic penalty for not exercising the option. The lease term commences on the
date when we have the right to control the use of the leased property, which is
typically before rent payments are due under the terms of the lease. 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. Percentage rent expense is generally based on
sales levels and is accrued at the point in time we determine that it is
probable that such sales levels will be achieved.
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 $214,608, $210,989 and $200,020, in
fiscal 2005, 2004 and 2003, respectively.
Stock-Based Compensation
Statement of Financial Accounting Standards (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.
24
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
-------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------------------
Net earnings, as reported $ 290,606 $ 227,173 $225,979
Add: Stock-based compensation expense included in
reported net earnings, net of related tax effects 5,134 3,158 2,642
Deduct: Total stock-based compensation expense
determined under fair value based method for all
awards, net of related tax effects (22,719) (17,980) (19,801)
-----------------------------------------------
Pro forma $ 273,021 $ 212,351 $208,820
===============================================
Basic net earnings per share
As reported $ 1.85 $ 1.39 $ 1.33
Pro forma $ 1.74 $ 1.30 $ 1.23
Diluted net earnings per share
As reported $ 1.78 $ 1.34 $ 1.27
Pro forma $ 1.67 $ 1.25 $ 1.18
===================================================================================================================
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.
The weighted-average assumptions used in the Black Scholes model were as
follows:
Stock Options
Granted in Fiscal Year
-------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------------------
Risk-free interest rate 3.75% 2.62% 4.37%
Expected volatility of stock 30.0% 30.0% 30.0%
Dividend yield 0.3% 0.2% 0.2%
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 and restricted stock
granted by us represent the only dilutive effect reflected in diluted
weighted-average shares outstanding. Options and restricted stock do not impact
the numerator of the diluted net earnings per share computation.
25
Options to purchase 2,680,412 shares, 4,643,389 shares and 3,952,618 shares of
common stock were excluded from the calculation of diluted net earnings per
share for fiscal 2005, 2004 and 2003, 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 accounting principles
generally accepted in the United States of America. 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
$8,724 and $10,174 at May 29, 2005 and May 30, 2004, respectively. Losses from
foreign currency transactions, which amounted to $18, $53 and $105, are included
in the consolidated statements of earnings for fiscal 2005, 2004 and 2003,
respectively.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 29, 2005, we operated 1,381 Red Lobster, Olive Garden, Bahama Breeze,
Smokey Bones Barbeque & Grill and Seasons 52 restaurants in North America as
operating segments. 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 operating segments into a single reporting segment.
Future Application of Accounting Standards
In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 151, "Inventory Costs." SFAS No. 151 clarifies the accounting for abnormal
amounts of idle facilities expense, freight, handling costs and wasted material.
SFAS No. 151 is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. We do not believe the adoption of SFAS No. 151
will have a material impact on our financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-Monetary
Assets." SFAS No. 153 eliminates the exception for non-monetary exchanges of
similar productive assets and replaces it with a general exception for exchanges
of non-monetary assets that do not have commercial substance. SFAS No. 153 is
effective for non-monetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. We do not believe the adoption of SFAS No. 153 will have a
material impact on our financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised), "Share-Based Payment."
SFAS No. 123R revises SFAS No. 123, "Accounting for Stock-Based Compensation"
and generally requires the cost associated with employee services received in
exchange for an award of equity instruments be measured based on the grant-date
fair value of the award and recognized in the financial statements over the
period during which employees are required to provide service in exchange for
the award. SFAS No. 123R also provides guidance on how to determine the
grant-date fair value for awards of equity instruments as well as alternative
methods of adopting its requirements. SFAS No. 123R is effective for annual
reporting periods beginning after June 15, 2005. As disclosed in Note 1, based
on the current assumptions and calculations used, had we recognized compensation
expense based on the fair value of awards of equity instruments, net earnings
would have been reduced by approximately $17,585, $14,822 and $17,159 for fiscal
2005, 2004 and 2003, respectively. We have not yet determined the method of
adoption or the effect of adopting SFAS No. 123R and have not determined whether
the adoption will result in future amounts similar to the current pro forma
disclosures under SFAS No. 123.
26
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 $20,296 and $20,276 at May 29, 2005 and May
30, 2004, respectively. The allowance for doubtful accounts associated with all
of our receivables amounted to $400 and $350 at May 29, 2005 and May 30, 2004,
respectively.
NOTE 3 - RESTRUCTURING AND ASSET IMPAIRMENT ACTIVITIES
Asset impairment charges related to the decision to relocate or rebuild certain
restaurants amounted to $900, $5,667 and $4,876 in fiscal 2005, 2004 and 2003,
respectively. Asset impairment credits related to assets sold that were
previously impaired amounted to $2,786, $1,437 and $594 in fiscal 2005, 2004 and
2003, respectively. During fiscal 2005, we also recorded charges of $6,407 for
the write-down of carrying value of two Olive Garden restaurants, one Red
Lobster restaurant and one Smokey Bones restaurant. The Smokey Bones restaurant
was closed subsequent to fiscal 2005 while the two Olive Garden restaurants and
one Red Lobster restaurant continued to operate. All impairment amounts are
included in asset impairment and restructuring charges in the consolidated
statements of earnings.
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 for fiscal
2005:
Balance at May Balance at
29, 2004 Additions Cash Payments May 30, 2005
- -------------------------------------------------------------------------------------------------------------
One-time termination benefits $ 49 $ -- $ (49) $ --
Lease termination costs -- -- -- --
Other exit costs 311 -- (311) --
- -------------------------------------------------------------------------------------------------------------
$ 360 $ -- $ (360) $ --
=============================================================================================================
The results of operations for all restaurants closed in fiscal 2005, 2004 and
2003 are not material to our consolidated results of operations and, therefore,
have not been presented as discontinued operations.
NOTE 4 - LAND, BUILDINGS AND EQUIPMENT, NET
The components of land, buildings and equipment, net, are as follows:
May 29, 2005 May 30, 2004
-------------------------------------------------------------------------------
Land $ 565,965 $ 545,191
Buildings 2,306,342 2,138,376
Equipment 1,036,143 1,008,133
Construction in progress 107,750 87,655
-------------------------------------------------------------------------------
Total land, buildings and equipment 4,016,200 3,779,355
Less accumulated depreciation (1,664,746) (1,528,739)
-------------------------------------------------------------------------------
Net land, buildings, and equipment, net $ 2,351,454 $ 2,250,616
===============================================================================
27
NOTE 5 - OTHER ASSETS
The components of other assets are as follows:
May 29, 2005 May 30, 2004
-------------------------------------------------------------------------------
Prepaid pension costs $ 63,475 $ 67,077
Trust-owned life insurance 43,873 40,422
Capitalized software costs, net 31,165 32,328
Liquor licenses 24,570 22,201
Prepaid interest and loan costs 8,008 12,396
Miscellaneous 7,960 9,001
-------------------------------------------------------------------------------
Total other assets $ 179,051 $ 183,425
===============================================================================
NOTE 6 - SHORT-TERM DEBT
Short-term debt at May 29, 2005 and May 30, 2004, consisted of $0 and $14,500,
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.
NOTE 7 - OTHER CURRENT LIABILITIES
The components of other current liabilities are as follows:
May 29, 2005 May 30, 2004
-------------------------------------------------------------------------------
Employee benefits $134,272 $115,083
Sales and other taxes 39,011 40,122
Insurance 35,938 38,254
Miscellaneous 34,458 24,388
Accrued interest 10,499 10,477
-------------------------------------------------------------------------------
Total other current liabilities $254,178 $228,324
===============================================================================
NOTE 8 - LONG-TERM DEBT
The components of long-term debt are as follows:
May 29, 2005 May 30, 2004
-------------------------------------------------------------------------------------------------------------------
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 (3.42%
at May 29, 2005) due December 2018 26,010 29,403
-------------------------------------------------------------------------------------------------------------------
Total long-term debt 651,010 654,403
Less issuance discount (763) (1,054)
-------------------------------------------------------------------------------------------------------------------
Total long-term debt less issuance discount 650,247 653,349
Less current portion (299,929) --
-------------------------------------------------------------------------------------------------------------------
Long-term debt, excluding current portion $ 350,318 $ 653,349
===================================================================================================================
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 29, 2005, our shelf registration provides for the issuance of
an additional $125,000 of unsecured debt securities.
28
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 29, 2005 and May 30, 2004, no borrowings were outstanding and
we were in compliance with the covenants under this credit facility.
The aggregate maturities of long-term debt for each of the five fiscal years
subsequent to May 29, 2005, and thereafter are $300,000 in 2006, $150,000 in
2007, $0 in 2008, 2009 and 2010 and $201,010 thereafter.
NOTE 9 - 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. We also use equity related derivative instruments
to manage our exposure on cash compensation arrangements indexed to the market
price of our common stock. 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, commodity prices, or market price of our common stock. We minimize this
market risk by establishing and monitoring parameters that limit the types and
degree of market risk that may be undertaken.
Futures Contracts and Commodity Swaps
During fiscal 2005 and 2004, we entered into futures contracts and commodity
swaps to reduce the risk of natural gas 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 accumulated other comprehensive income (loss).
These changes in fair value are subsequently reclassified into earnings when the
natural gas is purchased and used by us in our operations. Net losses of $311
and $439 related to these derivatives were recognized in earnings during fiscal
2005 and 2004, respectively. The fair value of these contracts was a net gain of
$60 at May 29, 2005 and is expected to be reclassified from accumulated other
comprehensive income (loss) into restaurant expenses during the next nine
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 29, 2005, the maximum length of time over which we are hedging our
exposure to the variability in future natural gas cash flows is 12 months. No
gains or losses were reclassified into earnings during fiscal 2005 or fiscal
2004 as a result of the discontinuance of natural gas 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 (loss). 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. Annual amortization of $53 was recognized in earnings as
an adjustment to interest expense during fiscal 2005, 2004 and 2003. It is
29
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 2005 and 2004, we entered into interest rate swap agreements
(swaps) to hedge the risk of changes in interest rates of a future issuance of
fixed-rate debt. The swaps, which have a $100,000 notional principal amount of
indebtedness, will be used to hedge 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
accumulated other comprehensive income (loss). 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
29, 2005 was a loss of $3,131 and is included in accumulated other comprehensive
income (loss) at May 29, 2005. No amounts were recognized in earnings during
fiscal 2005 and 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 8).
Equity Forwards
During fiscal 2005, we entered into equity forward contracts to hedge the risk
of changes in future cash flows associated with the unvested unrecognized Darden
stock units granted during the first quarter of fiscal 2005 (see Note 16). The
equity forward contracts will be settled at the end of the vesting periods of
their underlying Darden stock units, which range between four and five years.
The equity forward contracts, which are indexed to 200,000 shares of our common
stock, have a $3,904 notional amount and can only be net settled in cash. The
equity forward contracts are used to hedge the variability in cash flows
associated with the unvested unrecognized Darden stock units. To the extent the
equity forward contracts are effective in offsetting the variability of the
hedged cash flows, changes in the fair value of the equity forward contracts are
not included in current earnings but are reported as accumulated other
comprehensive income (loss). A deferred gain of $2,185 related to the equity
forward contracts was recognized in accumulated other comprehensive income
(loss) at May 29, 2005. As the Darden stock units vest, we will effectively
de-designate that portion of the equity forward contract that no longer
qualifies for hedge accounting and changes in fair value associated with that
portion of the equity forward contract will be recognized in current earnings. A
gain of $471 was recognized in earnings as a component of restaurant labor
during fiscal 2005.
NOTE 10 - 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 29, 2005 was $650,247
and $686,040, respectively. The carrying value and fair value of long-term debt
at May 30, 2004 was $653,349 and $700,383, 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.
NOTE 11 - STOCKHOLDERS' EQUITY
Treasury Stock
Our Board of Directors has authorized us to repurchase up to 137.4 million
shares of our common stock. In fiscal 2005, 2004 and 2003, we purchased treasury
stock totaling $311,686, $235,462 and $213,311, respectively. At May 29, 2005, a
total of 120.6 million shares have been repurchased under the authorization. The
repurchased common stock is reflected as a reduction of stockholders' equity.
30
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
under the Loan Program. We account for outstanding officer notes receivable as a
reduction of stockholders' equity.
Stockholders' Rights Plan
Under our Rights Agreement dated as of May 16, 2005, each share of our common
stock has associated with it one right to purchase one-thousandth of a share of
our Series A Participating Cumulative Preferred Stock at a purchase price of
$120, subject to adjustment under certain circumstances to prevent dilution. The
rights are exercisable when, and are not transferable apart from our common
stock until, a person or group has acquired 15 percent or more, or makes a
tender offer for 15 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 25, 2015.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) are as follows:
May 29, 2005 May 30, 2004
-----------------------------------------------------------------------------------------------------------------
Foreign currency translation adjustment $(8,724) $(10,174)
Unrealized gains on derivatives, net of tax 345 587
Minimum pension liability adjustment, net of tax (497) (586)
-----------------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive income (loss) $(8,876) $(10,173)
=================================================================================================================
Reclassification adjustments associated with pre-tax net derivative income
(losses) realized in net earnings for fiscal 2005, 2004 and 2003 amounted to
$213, $(386) and $994, respectively.
NOTE 12 - LEASES
An analysis of rent expense incurred under operating leases is as follows:
Fiscal Year
-------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------------------
Restaurant minimum rent $62,116 $56,462 $48,121
Restaurant percentage rent 4,036 3,820 3,682
Restaurant equipment minimum rent 7 57 5,719
Restaurant rent averaging expense 7,636 7,522 9,482
Transportation equipment 3,083 2,514 2,665
Office equipment 1,200 1,302 1,138
Office space 1,129 1,286 1,713
Warehouse space 325 315 303
-------------------------------------------------------------------------------------------------------------------
Total rent expense $79,532 $73,278 $72,823
===================================================================================================================
The annual non-cancelable future lease commitments for each of the five fiscal
years subsequent to May 29, 2005 and thereafter are: $68,301 in 2006, $63,598 in
2007, $56,112 in 2008, $48,112 in 2009, $40,352 in 2010 and $143,068 thereafter,
for a cumulative total of $419,543.
31
NOTE 13 - INTEREST, NET
The components of interest, net, are as follows:
Fiscal Year
-------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------------------
Interest expense $47,656 $47,710 $47,566
Capitalized interest (3,182) (3,500) (3,470)
Interest income (1,355) (551) (1,499)
-------------------------------------------------------------------------------------------------------------------
Interest, net $43,119 $43,659 $42,597
===================================================================================================================
Capitalized interest was computed using our average borrowing rate. We paid
$39,083, $39,661 and $38,682, for interest (excluding amounts capitalized) in
fiscal 2005, 2004 and 2003, respectively.
NOTE 14 - INCOME TAXES
The components of earnings before income taxes and the provision for income
taxes thereon are as follows:
Fiscal Year
-------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------------------
Earnings before income taxes:
U.S. $ 416,905 $ 328,577 $ 335,611
Canada 7,012 4,199 1,992
-------------------------------------------------------------------------------------------------------------------
Earnings before income taxes $ 423,917 $ 332,776 $ 337,603
-------------------------------------------------------------------------------------------------------------------
Income taxes:
Current:
Federal $ 137,549 75,121 $ 68,178
State and local 20,438 13,663 11,396
Canada 46 131 24
-------------------------------------------------------------------------------------------------------------------
Total current $ 158,033 $ 88,915 $ 79,598
-------------------------------------------------------------------------------------------------------------------
Deferred (principally U.S.) (24,722) 16,688 32,026
-------------------------------------------------------------------------------------------------------------------
Total income taxes $ 133,311 $ 105,603 $ 111,624
===================================================================================================================
During fiscal 2005, 2004 and 2003, we paid income taxes of $111,386, $92,265 and
$65,398, 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
-------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------------------
U.S. statutory rate 35.0% 35.0% 35.0%
State and local income taxes, net of federal tax benefits 2.9 3.2 3.0
Benefit of federal income tax credits (5.0) (5.2) (4.5)
Other, net (1.5) (1.3) (0.4)
-------------------------------------------------------------------------------------------------------------------
Effective income tax rate 31.4% 31.7% 33.1%
===================================================================================================================
32
The tax effects of temporary differences that give rise to deferred tax assets
and liabilities are as follows:
May 29, 2005 May 30, 2004
-------------------------------------------------------------------------------------------------------------------
Accrued liabilities $ 18,016 $ 13,286
Compensation and employee benefits 76,680 63,234
Deferred rent and interest income 33,149 28,094
Asset disposition and restructuring liabilities 2,239 2,651
Other 4,537 2,918
-------------------------------------------------------------------------------------------------------------------
Gross deferred tax assets $ 134,621 $ 110,183
-------------------------------------------------------------------------------------------------------------------
Buildings and equipment (145,421) (143,910)
Prepaid pension costs (24,115) (25,452)
Prepaid interest (1,205) (1,333)
Capitalized software and other assets (11,334) (15,976)
Other (3,808) (944)
-------------------------------------------------------------------------------------------------------------------
Gross deferred tax liabilities $ (185,883) $ (187,615)
-------------------------------------------------------------------------------------------------------------------
Net deferred tax liabilities $ (51,262) $ (77,432)
===================================================================================================================
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 29, 2005 and May 30, 2004, 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 15- 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 2005, 2004 and 2003, we
funded the defined benefit pension plans in the amount of $103, $85 and $20,063,
respectively. We expect to contribute approximately $200 to our defined benefit
pension plans during fiscal 2006. During fiscal 2005, 2004 and 2003, we funded
the postretirement benefit plan in the amount of $472, $172 and $140,
respectively. We expect to contribute approximately $400 to our postretirement
benefit plan during fiscal 2006.
33
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, 2005 and 2004:
Defined Benefit Plans Postretirement Benefit Plan
- ---------------------------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------
Change in Benefit Obligation:
Benefit obligation at beginning of period $143,689 $129,636 $ 16,885 $ 14,809
Service cost 4,840 4,516 699 626
Interest cost 7,315 7,077 1,006 920
Participant contributions -- -- 145 128
Benefits paid (5,387) (5,554) (544) (300)
Actuarial loss (gain) 7,739 8,014 (1,821) 702
- ---------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of period $158,196 $143,689 $ 16,370 $ 16,885
=====================================================================================================================
Change in Plan Assets:
Fair value at beginning of period $145,252 $115,962 $ -- $ --
Actual return on plan assets 18,162 34,759 -- --
Employer contributions 88 85 399 172
Participant contributions -- -- 145 128
Benefits paid (5,387) (5,554) (544) (300)
- ---------------------------------------------------------------------------------------------------------------------
Fair value at end of period $158,115 $145,252 $ -- $ --
=====================================================================================================================
Reconciliation of the Plan's Funded Status:
Funded status at end of period $ (81) $ 1,563 $ (16,370) $ (16,885)
Unrecognized prior service cost (22) (479) -- --
Unrecognized actuarial loss 59,379 62,062 4,292 6,458
Contributions for March to May 37 22 150 77
- ---------------------------------------------------------------------------------------------------------------------
Prepaid (accrued) benefit costs $ 59,313 $ 63,168 $ (11,928) $ (10,350)
=====================================================================================================================
Components of the Consolidated Balance
Sheets:
Prepaid benefit costs $ 63,475 $ 67,077 $ -- $ --
Accrued benefit costs (4,974) (4,859) (11,928) (10,350)
Accumulated other comprehensive loss 812 950 -- --
- ---------------------------------------------------------------------------------------------------------------------
Net asset (liability) recognized $ 59,313 $ 63,168 $ (11,928) $ (10,350)
=====================================================================================================================
The accumulated benefit obligation for all pension plans was $150,841 and
$135,950 at May 29, 2005 and May 30, 2004, respectively. The accumulated benefit
obligation and fair value of plan assets for pension plans with accumulated
benefit obligations in excess of plan assets were $5,011 and $0, respectively,
at February 28, 2005 and $4,881 and $0, respectively, at February 28, 2004. The
projected benefit obligation for pension plans with projected benefit
obligations in excess of plan assets approximated their accumulated benefit
obligation at February 28, 2005 and February 28, 2004.
34
The following table presents the weighted-average assumptions used to determine
benefit obligations and net expense:
Defined Benefit Plans Postretirement Benefit Plan
- ------------------------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Weighted-average assumptions used to determine
benefit obligations at May 29 and May 30, (1)
Discount rate 5.75% 6.00% 5.75% 6.00%
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 29
and May 30, (2)
Discount rate 6.00% 6.25% 6.00% 6.25%
Expected long-term rate of return on plan assets 9.00% 9.00% 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, 2005 and 2004,
respectively:
- --------------------------------------------------------------------------------
2005 2004
- --------------------------------------------------------------------------------
U.S. equities 37% 38%
High-quality, long-duration fixed-income securities 24% 26%
International equities 20% 18%
Real assets 13% 12%
Private equities 6% 6%
- --------------------------------------------------------------------------------
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 10.9 percent as of May 29, 2005.
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 10.0 percent to 11.0 percent for fiscal 2006, depending on
the medical service category. The rates gradually decrease to 5.0 percent
through fiscal 2011 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 $620 and $485, respectively, and would increase or decrease the accumulated
postretirement benefit obligation by $3,507 and $2,744, respectively.
35
Components of net periodic benefit cost (income) are as follows:
Defined Benefit Plans Postretirement Benefit Plan
- -----------------------------------------------------------------------------------------------------------------------
2005 2004 2003 2005 2004 2003
- -----------------------------------------------------------------------------------------------------------------------
Service cost $ 4,840 $ 4,516 $ 3,732 $ 699 $ 626 $ 388
Interest cost 7,315 7,076 7,088 1,005 919 648
Expected return on plan assets (12,841) (12,821) (12,739) -- -- --
Amortization of unrecognized prior service cost (348) (348) (348) -- 29 18
Recognized net actuarial loss 4,992 3,710 1,924 346 334 46
- -----------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost (income) $ 3,958 $ 2,133 $ (343) $ 2,050 $ 1,908 $ 1,100
=======================================================================================================================
The following benefit payments are expected to be paid:
- --------------------------------------------------------------------------------
Defined Benefit Postretirement
Plans Benefit Plan
- --------------------------------------------------------------------------------
2006 $ 5,666 $ 292
2007 6,283 340
2008 6,756 386
2009 7,151 453
2010 7,628 503
2011-2015 46,695 3,696
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 $498,125 at May 29, 2005 and $390,461 at May 30, 2004.
Expense recognized in fiscal 2005, 2004 and 2003, was $2,713, $2,666 and $1,732,
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 $108,407
and $88,569 at May 29, 2005 and May 30, 2004, 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 2005, 2004 and 2003,
the ESOP incurred interest expense of $677, $473 and $697, respectively, and
used dividends received of $1,235, $454 and $1,002, respectively, and
contributions received from us of $3,389, $4,093 and $4,266, respectively, to
pay principal and interest on our debt.
These ESOP shares are included in average common shares outstanding for purposes
of calculating net earnings per share. At May 29, 2005, the ESOP's debt to us
had a balance of $26,010 with a variable rate of interest of 3.42 percent;
$9,110 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 held in the ESOP at May 29, 2005 approximated
9,810,000 shares, representing 4,211,000 allocated shares, 9,000
committed-to-be-released shares and 5,590,000 suspense shares.
At the end of fiscal 2005, the ESOP borrowed $1,606 from us at a variable
interest rate and acquired an additional 50,000 shares of our common stock,
which were held in suspense within the ESOP at May 29, 2005. The loan, which had
a variable interest rate of 3.42 percent at May 29, 2005, is due to be repaid no
later than December 2018. The shares acquired under this loan are accounted for
in accordance with Statement of Position (SOP) 93-6, "Employers Accounting for
Employee Stock Ownership Plans." Fluctuations in our stock price are recognized
as adjustments to common stock and surplus when the shares are committed to be
released. These ESOP shares are not
36
considered outstanding until they are committed to be released and, therefore,
have been excluded for purposes of calculating basic and diluted net earnings
per share at May 29, 2005. The fair value of these shares at May 29, 2005 was
$1,624.
NOTE 16 - STOCK PLANS
We maintain two active stock option and stock grant plans under which new awards
may still be issued: 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 Stock Option and Long-Term Incentive Plan of 1995 (1995
Plan) and the Restaurant Management and Employee Stock Plan of 2000 (2000 Plan).
All of the plans are administered by the Compensation Committee of the Board of
Directors. 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, RSUs,
stock awards and other stock-based awards 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, restricted stock and RSUs to non-employee
directors. The 1995 Plan provided for the issuance of up to 33,300,000 common
shares in connection with the granting of non-qualified stock options,
restricted stock or RSUs to key employees. No new awards could be made under the
1995 Plan after September 30, 2004. 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. As noted above, no new awards may be
made under the 1995 Plan and the 2000 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 are issued under the plan at a value equal
to the market price in consideration of foregone retainer and meeting fees.
The per share weighted-average fair value of stock options granted during fiscal
2005, 2004 and 2003 was $7.75, $6.83 and $9.01, 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 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
-------------------------------------------------------------------------------------------------------------------
Options granted 2,147,650 $ 21.88
Options exercised (6,614,735) $ 10.51
Options cancelled (607,550) $ 21.20
-------------------------------------------------------------------------------------------------------------------
Balance at May 29, 2005 11,879,660 $13.28 20,579,002 $ 16.86
-------------------------------------------------------------------------------------------------------------------
The following table provides information regarding exercisable and outstanding
options at May 29, 2005:
37
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 1,696,626 $ 6.42 1,696,626 $ 6.42 1.9
$10.01 - $15.00 6,933,340 11.97 6,933,340 11.97 4.2
$15.01 - $20.00 2,185,049 17.07 5,746,334 17.87 6.9
$20.01 - $25.00 559,929 22.93 3,497,264 21.93 8.5
Over $25.00 504,716 27.20 2,705,438 27.28 7.3
-------------------------------------------------------------------------------------------------------------------
11,879,660 $ 13.28 20,579,002 $16.86 5.9
===================================================================================================================
We granted restricted stock and RSUs during fiscal 2005, 2004 and 2003 totaling
500,917, 513,305 and 275,610, respectively. The per share weighted-average fair
value of the awards granted in fiscal 2005, 2004 and 2003 was $21.82, $19.45 and
$26.53, respectively. After giving consideration to vesting terms, assumed
forfeiture rates and subsequent forfeiture adjustments, compensation expense
recognized in net earnings for awards granted in fiscal 2005, 2004 and 2003
amounted to $7,464, $4,198 and $3,579, respectively.
During fiscal 2005, we issued Darden stock units to certain key employees. The
Darden stock units were granted at a value equal to the market price of our
common stock at the date of grant and will be settled in cash at the end of
their vesting periods, which range between four and five years, at the then
market price of our common stock. Compensation expense is measured based on the
market price of our common stock each period and is amortized over the vesting
period. At May 29, 2005, we had 436,870 Darden stock units outstanding. No
Darden stock units were outstanding during fiscal 2004 and 2003.
NOTE 17 - 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 3,600,000 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 2005, 2004 and 2003, employees
purchased shares of common stock under the plan totaling 266,407, 319,299 and
261,409, respectively. At May 29, 2005, an additional 1,692,748 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, net of related tax effects, in fiscal 2005, 2004 and 2003 and had no
impact on reported basic or diluted net earnings per share.
NOTE 18 - COMMITMENTS AND CONTINGENCIES
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 29, 2005 and May 30, 2004, we had
$72,677 and $72,480, respectively, of standby letters of credit related to
workers' compensation and general liabilities accrued in our consolidated
financial statements. At May 29, 2005 and May 30, 2004, we had $13,829 and
$15,896, 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 29, 2005 and May 30, 2004, we had $1,768 and $4,346, respectively, of
guarantees associated with leased properties that have been assigned to third
parties. These amounts represent the maximum potential amount of future payments
under the guarantees. The fair value of these potential payments discounted at
our pre-tax cost of capital at May 29, 2005 and May 30, 2004, amounted to $1,395
and $3,131, respectively. We did not accrue for the guarantees, as the
likelihood of the third parties defaulting on the assignment agreements was less
than probable. In the event of default by a third party, the indemnity and/or
default clauses in our assignment agreements govern our ability to recover from
and pursue the third party for damages incurred as a result of its default. We
do not hold any third-party assets as collateral related to these assignment
agreements, except to the extent that the assignment allows
38
us to repossess the building and personal property. These guarantees expire over
their respective lease terms, which range from fiscal 2007 through fiscal 2012.
We are subject to private lawsuits, administrative proceedings and claims that
arise in the ordinary course of our business. A number of these lawsuits,
proceedings and claims may exist at any given time. These matters typically
involve claims from guests, employees and others related to operational issues
common to the restaurant industry, and can also involve infringement of, or
challenges to, our trademarks. While the resolution of a lawsuit, proceeding or
claim may have an impact on our financial results for the period in which it is
resolved, we believe that the final disposition of the lawsuits, proceedings and
claims in which we are currently involved, either individually or in the
aggregate, will not have a material adverse effect on our financial position,
results of operations or liquidity.
Like other restaurant companies and retail employers, we have been faced in a
few states with allegations of purported class-wide wage and hour violations.
The following is a brief description of the more significant of these matters.
In view of the inherent uncertainties of litigation, the outcome of any
unresolved matter described below cannot be predicted at this time, nor can the
amount of any potential loss be reasonably estimated.
In March 2003 and March 2002, two purported class action lawsuits were brought
against us in the Superior Court of Orange County, California by three current
and former hourly restaurant employees alleging violations of California labor
laws with respect to providing meal and rest breaks. Although we continue to
believe we provided the required meal and rest breaks to our employees, to avoid
potentially costly and protracted litigation, we agreed during the second
quarter of fiscal 2005 to settle both lawsuits and a similar case filed in
Sacramento County, for approximately $9,500. Terms of the settlement, which do
not include any admission of liability by us, have received preliminary judicial
approval, but completion of the settlement may not occur for several months. We
recorded settlement expenses associated with these lawsuits of approximately
$4,500 during fiscal 2005 and $5,000 during fiscal 2004, which are included in
selling, general and administrative expenses. The settlement amounts of these
lawsuits are included in other current liabilities at May 29, 2005.
In August 2003, three former employees in Washington filed a similar purported
class action in Washington State Superior Court in Spokane County alleging
violations of Washington labor laws with respect to providing rest breaks. The
Court stayed the action and ordered the plaintiffs into our mandatory
arbitration program; the plaintiffs' motion for reconsideration was not granted,
and their appeal of the denial of reconsideration was also not granted. We
believe we provided the required meal and rest breaks to our employees, and we
intend to vigorously defend our position in this case.
Beginning in 2002, a total of five purported class action lawsuits have been
filed in Superior Courts of California (two each in Los Angeles County and
Orange County, and one in Sacramento County) in which the plaintiffs allege that
they and other current and former service managers, beverage and hospitality
managers and culinary managers were improperly classified as exempt employees
under California labor laws. The plaintiffs seek unpaid overtime wages and
penalties. Two of the cases have been removed to arbitration under our mandatory
arbitration program, and we are seeking to cause the remaining cases to be
stayed pending resolution of the earliest-filed cases. We believe we properly
classified these employees as exempt under California law and we intend to
vigorously defend against all claims in these lawsuits.
39
NOTE 19 - QUARTERLY DATA (UNAUDITED)
The following table summarizes unaudited quarterly data for fiscal 2005 and
2004:
Fiscal 2005 - Quarters Ended
-------------------------------------------------------------------------------------------------------------------
Aug. 29 Nov. 28 Feb. 27 May 29 Total
-------------------------------------------------------------------------------------------------------------------
Sales $1,278,644 $1,229,373 $1,375,879 $1,394,214 $5,278,110
Earnings before income taxes 108,086 63,368 130,824 121,639 423,917
Net earnings 71,012 42,975 92,630 83,989 290,606
Net earnings per share:
Basic 0.45 0.27 0.59 0.54 1.85
Diluted 0.44 0.26 0.56 0.52 1.78
Dividends paid per share -- 0.04 -- 0.04 0.08
Stock price:
High 22.61 27.70 29.63 33.11 33.11
Low 19.30 20.33 26.17 25.78 19.30
===================================================================================================================
Fiscal 2004 - Quarters Ended
-------------------------------------------------------------------------------------------------------------------
Aug. 24 Nov. 23 Feb. 22 May 30 (1) Total
-------------------------------------------------------------------------------------------------------------------
Sales $1,259,689 $1,142,543 $1,241,952 $1,359,171 $5,003,355
Earnings before income taxes 101,977 44,688 111,404 74,707 332,776
Net earnings 67,351 30,053 77,088 52,681 227,173
Net earnings per share:
Basic 0.41 0.18 0.47 0.33 1.39
Diluted 0.40 0.18 0.45 0.32 1.34
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
===================================================================================================================
<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>
40
Five-Year Financial Summary
(In thousands, except per share data)
Fiscal Year Ended
-----------------------------------------------------------------------------------------------------------------------
May 29, May 30, May 25, May 26, May 27,
Operating Results 2005 2004 (1) 2003 2002 2001
-----------------------------------------------------------------------------------------------------------------------
Sales $5,278,110 $5,003,355 $4,654,971 $4,366,911 $3,992,419
-----------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of sales:
Food and beverage 1,593,709 1,526,875 1,449,162 1,384,481 1,302,926
Restaurant labor 1,695,805 1,601,258 1,485,046 1,373,416 1,261,837
Restaurant expenses 806,314 774,806 713,699 636,575 566,234
-----------------------------------------------------------------------------------------------------------------------
Total cost of sales, excluding restaurant
depreciation and amortization (2) $4,095,828 $3,902,939 $3,647,907 $3,394,472 $3,130,997
Selling, general and administrative 497,478 472,109 431,722 417,158 389,240
Depreciation and amortization 213,219 210,004 191,218 165,829 146,864
Interest, net 43,119 43,659 42,597 36,585 30,664
Asset impairment and restructuring charges
(credits), net 4,549 41,868 3,924 (2,568) --
-----------------------------------------------------------------------------------------------------------------------
Total costs and expenses $4,854,193 $4,670,579 $4,317,368 $4,011,476 $3,697,765
-----------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 423,917 332,776 337,603 355,435 294,654
Income taxes 133,311 105,603 111,624 122,664 101,707
-----------------------------------------------------------------------------------------------------------------------
Net earnings $ 290,606 $ 227,173 $ 225,979 $ 232,771 $ 192,947
-----------------------------------------------------------------------------------------------------------------------
Net earnings per share:
Basic $ 1.85 $ 1.39 $ 1.33 $ 1.33 $ 1.07
Diluted $ 1.78 $ 1.34 $ 1.27 $ 1.27 $ 1.04
-----------------------------------------------------------------------------------------------------------------------
Average number of common shares outstanding, net of shares held in Treasury:
Basic 156,700 163,500 170,300 174,700 179,600
Diluted 163,400 169,700 177,400 183,500 185,600
=======================================================================================================================
Financial Position
Total assets $2,937,771 $2,780,348 $2,664,633 $2,529,736 $2,216,534
Land, buildings and equipment 2,351,454 2,250,616 2,157,132 1,926,947 1,779,515
Working capital (deficit) (637,341) (337,174) (314,280) (157,662) (226,116)
Long-term debt, less current portion 350,318 653,349 658,086 662,506 520,574
Stockholders' equity 1,273,019 1,175,288 1,130,055 1,069,606 978,954
Stockholders' equity per outstanding shares 8.25 7.42 6.85 6.21 5.56
=======================================================================================================================
Other Statistics
Cash flow from operations $ 583,242 $ 525,411 $ 508,635 $ 508,101 $ 420,570
Capital expenditures 329,238 354,326 423,273 318,392 355,139
Dividends paid 12,505 12,984 13,501 9,225 9,458
Dividends paid per share 0.080 0.080 0.080 0.053 0.053
Advertising expense 214,608 210,989 200,020 184,163 177,998
Stock price:
High 33.11 25.60 27.83 29.767 19.660
Low 19.30 17.80 16.46 15.400 10.292
Close $ 32.80 $ 22.50 $ 18.35 $ 25.030 $ 19.267
Number of employees 150,100 141,300 140,700 133,200 128,900
Number of restaurants 1,381 1,325 1,271 1,211 1,168
=======================================================================================================================
<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
$198,422, $195,486, $177,127, $155,837 and $138,229, respectively.
</FN>
41