Red Lobster 2014 Annual Report Download - page 14

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
12 Darden Restaurants, Inc.
254 basis points, 249 basis points and 187 basis points would result in an
impairment of a portion of the goodwill of LongHorn Steakhouse, The Capital
Grille, Eddie V’s and Yard House, respectively. The estimated fair values of
LongHorn Steakhouse, The Capital Grille, Eddie V’s and Yard House exceeded
their carrying values by approximately 103 percent, 35 percent, 51 percent
and 25 percent, respectively.
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 impair-
ment 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, The Capital Grille, Eddie V’s and Yard House. The estimated fair
value of LongHorn Steakhouse’s trademark exceeded its carrying value of
$307.8 million by approximately 91 percent. The estimated fair value of The
Capital Grille’s trademark exceeded its carrying value of $147.0 million by
approximately 34 percent. The estimated fair value of Eddie V’s trademark
exceeded its carrying value of $10.5 million by approximately 100 percent.
The estimated fair value of Yard House trademark exceeded its carrying
value of $109.3 million by approximately 21 percent. A key assumption in
our fair value estimate is the discount rate utilized in the relief-from-royalty
method. We selected a discount rate of 11.0 percent for LongHorn Steakhouse
and The Capital Grille, 16.0 percent for Eddie V’s and 14.0 percent for
Yard House. An increase in the discount rate of approximately 630 basis
points, 240 basis points, 800 basis points and 187 basis points would
result in impairment of a portion of the trademarks of LongHorn Steakhouse,
The Capital Grille, Eddie V’s and Yard House, respectively.
We determined that there was no goodwill or trademark impairment as
of the first day of our fiscal 2014 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 manage-
ment’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 25, 2014, a write-down of goodwill, other
indefinite-lived intangible assets, or any other assets in excess of approxi-
mately $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, certain 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 analysis of 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 remain
unused is recognized over the expected period of redemption as the
remaining gift card values are redeemed, generally over a period of 10 years.
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 estimates of our redemption period and our breakage rate
periodically and apply that rate to gift card redemptions. Changing our
breakage-rate assumption on unredeemed gift cards by 25 basis points
would result in an adjustment in our unearned revenues of approximately
$15.0 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 statements 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.