Red Lobster 2012 Annual Report Download - page 28

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
24 Darden Restaurants, Inc. 2012 Annual Report
income approach. We selected a weighted-average cost of capital for LongHorn
Steakhouse and The Capital Grille of 11.0 percent. An increase in the weighted-
average cost of capital of approximately 680 basis points and approximately
220 basis points would result in an impairment of a portion of the goodwill of
LongHorn Steakhouse and The Capital Grille, respectively. The estimated fair
value of LongHorn Steakhouse exceeded its carrying value by approximately
171 percent. The estimated fair value of The Capital Grille exceeded its carrying
value by approximately 37 percent.
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 com-
pleted 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.
The estimated fair value of LongHorn Steakhouse’s trademark exceeded its
carrying value of $307.0 million by approximately 87 percent. The estimated
fair value of The Capital Grille’s trademark exceeded its carrying value of
$147.0 million by approximately 49 percent. As our calculation of the trademark
related to Eddie V’s was finalized in the fourth quarter of fiscal 2012, we did not
separately test the trademark for impairment. 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
12.0 percent. An increase in the discount rate of approximately 650 basis points
and approximately 310 basis points would result in impairment of a portion of
the trademarks 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 2012 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 trade-
marks. 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 27, 2012, a write-down of goodwill, other indefinite-lived
intangible assets, or any other assets in excess of approximately $850.0 million
would have been required to cause 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 our acquisitions, 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. 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 $25.5 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.