Red Lobster 2007 Annual Report Download - page 48

46 Darden Restaurants, Inc. Annual Report 2007
Notes to Consolidated Financial Statements
N
Note11
Note12
Option Contracts and Commodity Swaps
During fiscal 2007 and 2006, we entered into option contracts and
commodity swaps to reduce the risk of natural gas price fluctua-
tions. 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 included in accu-
mulated other comprehensive income (loss). These changes in fair
value are subsequently reclassified into earnings as a component of
restaurant expenses when the natural gas is purchased and used by
us in our operations. Net gains (losses) of ($4.6) million, $4.3 million
and ($0.3) million related to these derivatives were reclassified to
earnings during fiscal 2007, 2006 and 2005, respectively, in connec-
tion with the settlement of our contracts. As of May 27, 2007 we
were party to option contracts and commodity swaps with aggre-
gate notional values of $20.2 million. The fair value of these contracts
was a net gain of $1.9 million at May 27, 2007 and is expected to be
reclassified from accumulated other comprehensive income (loss)
into restaurant expenses during fiscal 2008. To the extent that these
derivatives are not effective, changes in their fair value are immedi-
ately recognized in current earnings. Additionally, during fiscal 2007,
in connection with a reduction in expected natural gas usage in
fiscal 2008 related to the closure of 54 Smokey Bones, two Rocky
River Grillhouse and nine Bahama Breeze restaurants, we liquidated
28 of our natural gas contracts resulting in the recognition of
$0.1 million of gains in fiscal 2007. The fair value of outstanding
derivatives is included in other current assets or other current
liabilities. At May 27, 2007, the maximum length of time over which
we are hedging our exposure to the variability in future natural gas
cash flows is 12 months.
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 $75.0 million notional
principal amount of indebtedness, was used to hedge a portion of
the interest payments associated with $150.0 million of debt subse-
quently issued in March 2002. The treasury lock was settled at the
time of the related debt issuance with a net gain of $0.3 million
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 recog-
nized in earnings. Annual amortization of $0.1 million was recog-
nized in earnings as an adjustment to interest expense during fiscal
2007, 2006 and 2005. As of May 27, 2007, the net gain on settlement
of the treasury lock had been fully amortized.
Interest Rate Swaps
During fiscal 2005 and fiscal 2004, we entered into interest rate swap
agreements (swaps) to hedge the risk of changes in interest rates on
the cost of a future issuance of fixed-rate debt. The swaps, which had
a $100.0 million notional principal amount of indebtedness, were
used to hedge a portion of the interest payments associated with
$150.0 million of unsecured 4.875 percent senior notes due in
August 2010, which were issued in August 2005. The swaps were
settled at the time of the related debt issuance with a net loss of
$1.2 million being recognized in accumulated other comprehensive
income (loss). The net loss on the swaps 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. A loss of $0.2 million was recognized
in earnings during each of fiscal 2007 and 2006 as an adjustment
to interest expense.
We also had interest rate swaps with a notional amount of
$200.0 million, which we used to convert variable rates on our long-
term debt to fixed rates effective May 30, 1995, related to the issuance
of our $150.0 million 6.375 percent notes due February 2006 and our
$100.0 million 7.125 percent debentures due February 2016. We
received the one-month commercial paper interest rate and paid
fixed-rate interest ranging from 7.51 percent to 7.89 percent. The
swaps were settled during January 1996 at a cost to us of $27.7 million.
A portion of the cost was recognized as an adjustment to interest
expense over the term of our 10-year 6.375 percent notes that were
settled at maturity in February 2006. The remaining portion continues
to be recognized as an adjustment to interest expense over the term
of our 20-year 7.125 percent debentures due 2016.
Equity Forwards
During fiscal 2007, 2006 and 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 quarters of fiscal 2007, 2006 and 2005 (see Note 17 – Stock-
Based Compensation for additional information). 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. In total, the equity forward contracts are indexed to 0.5 million
shares of our common stock, at varying forward rates between $19.52
per share and $41.17 per share, have a $14.2 million notional amount
and can only be net settled in cash. 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 $3.3 million related to
the equity forward contracts was recognized in accumulated other
comprehensive income (loss) at May 27, 2007. As the Darden stock