Red Lobster 2015 Annual Report Download - page 22

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DARDEN
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 $17.0 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.
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. Interest recognized on reserves for uncertain tax
positions is included in interest, net in our consolidated statements of earnings.
A corresponding liability for accrued interest is included as a component of
other current liabilities on our consolidated balance sheets. Penalties, when
incurred, are recognized in general and administrative expenses.
We base our estimates 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. For U.S. federal income tax purposes,
we participate in the Internal Revenue Service’s (IRS) Compliance Assurance
Process (CAP) whereby our U.S. federal income tax returns are reviewed by
the IRS both prior to and after their filing. Income tax returns are subject to
audit by 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. The major jurisdictions in which the Company
files income tax returns include the U.S. federal jurisdiction, Canada, and all
states in the U.S. that have an income tax. With a few exceptions, the Company
is no longer subject to U.S. federal income tax examinations by tax authorities
for years before fiscal 2014, and state and local, or non-U.S. income tax
examinations by tax authorities for years before fiscal 2011.
Included in the balance of unrecognized tax benefits at May 31, 2015
is $0.7 million related to tax positions for which it is reasonably possible
that the total amounts could change during the next 12 months based on
the outcome of examinations. The $0.7 million relates to items that would
impact our effective income tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows generated from operating activities are our principal source of
liquidity, which we use to fund the construction of new restaurants and to
remodel and maintain existing restaurants, to pay dividends to our shareholders
and to repurchase shares of our common stock. Since substantially all of our
sales are for cash and cash equivalents, and accounts payable are generally
due in 5 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 currently manage our business and financial ratios to maintain an
investment grade bond rating, which has historically allowed flexible access
to financing at reasonable costs. Currently, our publicly issued long-term
debt carries “Ba1” (Moody’s Investors Service), “BBB-” (Standard & Poor’s)
and “BBB-” (Fitch) ratings. Our commercial paper has ratings of “NP”
(Moody’s Investors Service), “A-3” (Standard & Poor’s) and “F-3” (Fitch).
These ratings are as of the date of the filing 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 are
not a recommendation to buy, sell or hold our securities, may be changed,
superseded or withdrawn at any time and should be evaluated independently
of any other rating.
We maintain a $750.0 million revolving Credit Agreement (Revolving
Credit Agreement), with Bank of America, N.A. (BOA) as administrative agent,
and the lenders and other agents party thereto. The Revolving Credit Agreement
is a senior unsecured credit commitment to the Company and contains
customary representations and affirmative and negative covenants (including
limitations on liens and subsidiary debt and a maximum consolidated lease
adjusted total debt to total capitalization ratio of 0.75 to 1.00) and events of
default usual for credit facilities of this type. As of May 31, 2015, we were in
compliance with all covenants under the Revolving Credit Agreement.