Red Lobster 2013 Annual Report Download - page 29

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
Darden Restaurants, Inc. 2013 Annual Report 25
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 10.0 percent of the current rate would result in an adjustment in our
unearned revenues of approximately $28.0 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.
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 differ-
ences 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 selling, 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 partici-
pate 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. During fiscal 2013, we were placed on CAP Maintenance by
the IRS, signaling our strong relationship of transparency and trust with the IRS
team. The U.S. federal income tax returns that we filed through the fiscal year
ended May 29, 2011 have been audited by the IRS. In the first quarter of fiscal
2013, the IRS issued a partial acceptance letter for the fiscal year ended May 27,
2012 tax return. The outstanding item as of the end of the current fiscal year
relates to our deductibility of the Domestic Manufacturing Deduction under
IRC Section 199, and is expected to be completed by the second quarter of fiscal
2014. The IRS commenced examination of our U.S. federal income tax returns
for May 26, 2013 in the first quarter of fiscal 2013. The examination is anticipated
to be completed by the second quarter of fiscal 2015. 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 2012, and state and local, or non-U.S. income tax examinations
by tax authorities for years before fiscal 2009.
Included in the balance of unrecognized tax benefits at May 26, 2013 is
$18.6 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 $18.6 million relates to items that would impact our effective
income tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows generated from operating activities provide us with a significant
source of liquidity, which we use to finance the purchases of land, buildings and
equipment for new restaurants, remodel existing restaurants, pay dividends to
our shareholders and repurchase shares of our common stock. Since substan-
tially 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 “Baa2” (Moody’s Investors Service), “BBB” (Standard & Poor’s) and “BBB”
(Fitch) ratings. Our commercial paper has ratings of “P-2” (Moody’s Investors
Service), “A-2” (Standard & Poor’s) and “F-2” (Fitch). These ratings are as of the date
of the filing of this annual report and have been obtained with the understand-
ing 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.