Red Lobster 2011 Annual Report Download - page 34

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
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Darden Restaurants, Inc.
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The fair value of trademarks are estimated and compared to the carrying
value. We estimate the fair value of trademarks using the relief-from-royalty
method, which requires assumptions related to projected sales from our annual
long-range฀plan;฀assumed฀royalty฀rates฀that฀could฀be฀payable฀if฀we฀did฀not฀own฀
the฀trademarks;฀and฀a฀discount฀rate.฀We฀recognize฀an฀impairment฀loss฀when฀
the estimated fair value of the trademarks is less than the carrying value. We
completed our impairment test and concluded as of the date of the test, there
was no impairment of the trademarks for LongHorn Steakhouse and The Capital
Grille. A key assumption in our fair value estimate is the discount rate utilized
in the relief-from-royalty method. We selected a discount rate for LongHorn
Steakhouse and The Capital Grille of 13.0 percent. An increase in the discount
rate of approximately 190 basis points and approximately 40 basis points would
result in impairment of a portion of the trademark of LongHorn Steakhouse and
The Capital Grille, respectively.
We determined that there was no goodwill or trademark impairment as of
the first day of our fiscal 2011 fourth quarter and no additional indicators of
impairment were identified through the end of our fiscal fourth quarter that
would require us to test further for impairment. However, declines in our market
capitalization (reflected in our stock price) as well as in the market capitalization
of other companies in the restaurant industry, declines in sales at our restaurants,
and significant adverse changes in the operating environment for the restaurant
industry may result in a future impairment loss.
Changes in circumstances, existing at the measurement date or at other
times in the future, or in the numerous estimates associated with management’s
judgments and assumptions made in assessing the fair value of our goodwill,
could result in an impairment loss of a portion or all of our goodwill or trademarks.
If we recorded an impairment loss, our financial position and results of operations
would be adversely affected and our leverage ratio for purposes of our credit
agreement would increase. A leverage ratio exceeding the maximum permitted
under our credit agreement would be a default under our credit agreement. At
May 29, 2011, a write down of our entire goodwill and trademarks balances would
not have caused our leverage ratio to exceed the permitted maximum. As our
leverage ratio is determined on a quarterly basis and due to the seasonal nature
of our business, a lesser amount of impairment in future quarters could cause
our leverage ratio to exceed the permitted maximum.
We evaluate the useful lives of our other intangible assets, primarily
intangible assets associated with the RARE acquisition, to determine if they
are definite or indefinite-lived. Reaching a determination on useful life
requires significant judgments and assumptions regarding the future effects
of obsolescence, demand, competition, other economic factors (such as the
stability of the industry, legislative action that results in an uncertain or changing
regulatory environment, and expected changes in distribution channels), the
level of required maintenance expenditures, and the expected lives of other
related groups of assets.
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 workers’ compensation and general liability claims that exceed
$0.5 million and $0.25 million, respectively. 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 about 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.
Unearned Revenues
Unearned revenues represent our liability for gift cards that have been sold but
not yet redeemed. We recognize sales from our gift cards when the gift card is
redeemed by the customer. Although there are no expiration dates or dormancy
fees for our gift cards, based on our historical gift card redemption patterns, we
can reasonably estimate the amount of gift cards for which redemption is remote,
which is referred to as “breakage”. We recognize breakage within sales for unused
gift card amounts in proportion to actual gift card redemptions, which is also
referred to as the “redemption recognition” method. The estimated value of gift
cards expected to go unused is recognized over the expected period of redemption
as the remaining gift card values are redeemed. Utilizing this method, we estimate
both the amount of breakage and the time period of redemption. If actual
redemption patterns vary from our estimates, actual gift card breakage income
may differ from the amounts recorded. We update our estimate of our breakage
rate periodically and apply that rate to gift card redemptions. Changing our
breakage-rate assumption on unredeemed gift cards by 10 percent of the current
rate would result in an adjustment in our unearned revenues of approximately
$21.0 million.
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. We adjust our annual effective income tax
rate as additional information on outcomes or events becomes available.
FASB ASC Topic 740, Income Taxes, requires that a position taken or expected
to be taken in a tax return be recognized (or derecognized) in the financial state-
ments when it is more likely than not (i.e., a likelihood of more than 50 percent)
that the position would be sustained upon examination by tax authorities. A
recognized tax position is then measured at the largest amount of benefit that is
greater than 50 percent likely of being realized upon ultimate settlement.