- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------ FORM 10-Q ------------ (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 27, 2005 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ............... to .................. 1-13666 Commission File Number --------------------------------- DARDEN RESTAURANTS, INC. (Exact name of registrant as specified in its charter) Florida 59-3305930 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 5900 Lake Ellenor Drive, Orlando, Florida 32809 (Address of principal executive offices) (Zip Code) 407-245-4000 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] Yes [ ] No Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No Number of shares of common stock outstanding as of December 27, 2005: 151,168,712 (excluding 122,336,429 shares held in our treasury). - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
DARDEN RESTAURANTS, INC. TABLE OF CONTENTS Page Part I - Financial Information Item 1. Financial Statements (Unaudited) 3 Consolidated Statements of Earnings 3 Consolidated Balance Sheets 4 Consolidated Statements of Changes in Stockholders' Equity and Accumulated Other Comprehensive Income (Loss) 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk 22 Item 4. Controls and Procedures 22 Part II - Other Information Item 1. Legal Proceedings 23 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24 Item 4. Submission of Matters to a Vote of Security Holders 25 Item 5. Other Information 25 Item 6. Exhibits 25 Signatures 26 Index to Exhibits 27 2
PART I FINANCIAL INFORMATION Item 1. Financial Statements <TABLE> <CAPTION> DARDEN RESTAURANTS, INC. CONSOLIDATED STATEMENTS OF EARNINGS (In thousands, except per share data) (Unaudited) Quarter Ended Six Months Ended - ---------------------------------------------------------------------------------------------------------------------- November 27, November 28, November 27, November 28, 2005 2004 2005 2004 - ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Sales.................................................. $1,325,093 $1,229,373 $2,734,260 $2,508,017 Costs and expenses: Cost of sales: Food and beverage................................. 389,575 368,036 808,770 759,457 Restaurant labor.................................. 440,956 400,714 890,115 806,530 Restaurant expenses............................... 215,081 202,287 429,775 397,304 ---------- ---------- ---------- --------- Total cost of sales, excluding restaurant depreciation and amortization of $50,600, $49,486, $101,020 and $98,705, respectively... $1,045,612 $ 971,037 $2,128,660 $1,963,291 Selling, general and administrative................. 132,181 130,785 265,216 245,365 Depreciation and amortization....................... 54,761 53,176 108,899 105,936 Interest, net....................................... 11,670 11,007 22,618 21,971 ---------- ----------- ---------- ---------- Total costs and expenses........................ $1,244,224 $1,166,005 $2,525,393 $2,336,563 ---------- ----------- ---------- ---------- Earnings before income taxes........................... 80,869 63,368 208,867 171,454 Income taxes........................................... (25,812) (20,393) (68,296) (57,467) ---------- ----------- ---------- ---------- Net earnings........................................... $ 55,057 $ 42,975 $ 140,571 $ 113,987 ========== =========== ========== ========== Net earnings per share: Basic.............................................. $ 0.37 $ 0.27 $ 0.93 $ 0.73 ========== =========== ========== ========== Diluted............................................ $ 0.35 $ 0.26 $ 0.89 $ 0.70 ========== =========== =========== ========== Average number of common shares outstanding: Basic.............................................. 149,600 156,800 151,400 157,200 ========== =========== ========== =========== Diluted............................................ 156,200 163,400 158,300 163,400 ========== =========== ========== =========== - ---------------------------------------------------------------------------------------------------------------------- </TABLE> See accompanying notes to consolidated financial statements. 3
<TABLE> <CAPTION> DARDEN RESTAURANTS, INC. CONSOLIDATED BALANCE SHEETS (In thousands) (Unaudited) - -------------------------------------------------------------------------------------------------------------------- November 27, 2005 May 29, 2005 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents................................. $ 72,536 $ 42,801 Short-term investments.................................... 10,000 -- Receivables............................................... 38,066 36,510 Inventories............................................... 247,353 235,444 Prepaid expenses and other current assets................. 31,723 28,927 Deferred income taxes..................................... 63,613 63,584 ------------ ------------ Total current assets.................................. $ 463,291 $ 407,266 Land, buildings and equipment, net........................... 2,404,948 2,351,454 Other assets................................................. 187,270 179,051 ------------ ------------ Total assets.......................................... $ 3,055,509 $ 2,937,771 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 209,767 $ 191,197 Accrued payroll........................................... 102,637 114,602 Accrued income taxes...................................... 43,993 52,404 Other accrued taxes....................................... 41,558 43,825 Unearned revenues......................................... 81,086 88,472 Current portion of long-term debt......................... 149,988 299,929 Other current liabilities................................. 259,522 254,178 ------------ ------------ Total current liabilities............................. $ 888,551 $ 1,044,607 Long-term debt, less current portion......................... 645,830 350,318 Deferred income taxes........................................ 103,821 114,846 Deferred rent................................................ 134,841 130,872 Other liabilities............................................ 27,676 24,109 ------------ ------------ Total liabilities..................................... $ 1,800,719 $ 1,664,752 ------------ ------------ Stockholders' equity: Common stock and surplus.................................. $ 1,758,851 $ 1,703,336 Retained earnings......................................... 1,516,471 1,405,754 Treasury stock............................................ (1,968,849) (1,784,835) Accumulated other comprehensive income (loss)............. (1,911) (8,876) Unearned compensation..................................... (49,283) (41,685) Officer notes receivable.................................. (489) (675) ------------ ------------ Total stockholders' equity............................ $ 1,254,790 $ 1,273,019 ------------ ------------ Total liabilities and stockholders' equity............ $ 3,055,509 $ 2,937,771 ============ ============ - -------------------------------------------------------------------------------------------------------------------- </TABLE> See accompanying notes to consolidated financial statements. 4
<TABLE> <CAPTION> DARDEN RESTAURANTS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) For the six months ended November 27, 2005 and November 28, 2004 (In thousands) (Unaudited) - ----------------------------------------------------------------------------------------------------------------------------------- Common Accumulated Stock Other Officer Total and Retained Treasury Comprehensive Unearned Notes Stockholders' Surplus Earnings Stock Income (Loss) Compensation Receivable Equity - ----------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at May 29, 2005.......... $1,703,336 $1,405,754 $(1,784,835) $ (8,876) $(41,685) $ (675) $1,273,019 Comprehensive income: Net earnings.................. -- 140,571 -- -- -- -- 140,571 Other comprehensive income (loss): Foreign currency adjustment................. -- -- -- 2,163 -- -- 2,163 Change in fair value of derivatives, net of tax of $2,646.................. -- -- -- 4,802 -- -- 4,802 ------------ Total comprehensive income................. 147,536 Cash dividends declared.......... -- (29,854) -- -- -- -- (29,854) Stock option exercises (1,888 shares)........................ 25,644 -- 3,472 -- -- -- 29,116 Issuance of restricted stock (403 shares), net of forfeiture adjustments.................... 12,735 -- -- -- (12,735) -- -- Earned compensation.............. -- -- -- -- 2,962 -- 2,962 ESOP note receivable repayments.. -- -- -- -- 2,175 -- 2,175 Income tax benefits credited to equity......................... 13,788 -- -- -- -- -- 13,788 Purchases of common stock for treasury(5,839 shares)........... -- -- (188,270) -- -- -- (188,270) Issuance of treasury stock under Employee Stock Purchase and other plans (122 shares)....... 3,348 -- 784 -- -- -- 4,132 Repayment of officer notes....... -- -- -- -- -- 186 186 - ----------------------------------------------------------------------------------------------------------------------------------- Balance at November 27, 2005 $1,758,851 $1,516,471 $(1,968,849) $ (1,911) $(49,283) $ (489) $1,254,790 - ----------------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------------- Common Accumulated Stock Other Officer Total and Retained Treasury Comprehensive Unearned Notes Stockholders' Surplus Earnings Stock Income (Loss) Compensation Receivable Equity - ----------------------------------------------------------------------------------------------------------------------------------- Balance at May 30, 2004.......... $1,584,115 $1,127,653 $(1,483,768) $ (10,173) $(41,401) $ (1,138) $1,175,288 Comprehensive income: Net earnings.................. -- 113,987 -- -- -- -- 113,987 Other comprehensive income (loss): Foreign currency adjustment................ -- -- -- 3,344 -- -- 3,344 Change in fair value of derivatives, net of tax of $1,308............. -- -- -- (650) -- -- (650) ----------- Total comprehensive income................ 116,681 Cash dividends declared.......... -- (6,251) -- -- -- -- (6,251) Stock option exercises (2,667 shares)........................ 24,357 -- 3,599 -- -- -- 27,956 Issuance of restricted stock (360 shares), net of forfeiture adjustments.................... 8,281 -- -- -- (8,281) -- -- Earned compensation.............. -- -- -- -- 3,411 -- 3,411 ESOP note receivable repayments.. -- -- -- -- 990 -- 990 Income tax benefits credited to equity......................... 13,704 -- -- -- -- -- 13,704 Purchases of common stock for treasury(3,179 shares)......... -- -- (68,743) -- -- -- (68,743) Issuance of treasury stock under Employee Stock Purchase and other plans (163 shares)....... 2,176 -- 1,153 -- -- -- 3,329 Repayment of officer notes, net.. -- -- -- -- -- 354 354 - ----------------------------------------------------------------------------------------------------------------------------------- Balance at November 28, 2004 $1,632,633 $1,235,389 $(1,547,759) $ (7,479) $(45,281) $ (784) $1,266,719 - ----------------------------------------------------------------------------------------------------------------------------------- </TABLE> See accompanying notes to consolidated financial statements. 5
<TABLE> <CAPTION> DARDEN RESTAURANTS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Quarter Ended Six Months Ended - ----------------------------------------------------------------------------------------------------------------------------- November 27, November 28, November 27, November 28, 2005 2004 2005 2004 - ----------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Cash flows--operating activities Net earnings................................................. $ 55,057 $ 42,975 $ 140,571 $ 113,987 Adjustments to reconcile net earnings to cash flows: Depreciation and amortization.............................. 54,761 53,176 108,899 105,936 Asset impairment charge (credit), net...................... 1,305 (108) 1,369 (113) Amortization of unearned compensation and loan costs....... 2,524 2,648 4,746 5,199 Non-cash compensation expense.............................. 1,086 945 1,220 973 Change in current assets and liabilities................... (78,125) 9,931 (23,171) (4,959) Contributions to defined benefit pension plans and postretirement plan...................................... (68) (45) (194) (151) Loss on disposal of land, buildings and equipment.......... 939 153 1,561 307 Change in cash surrender value of trust owned life insurance................................................ (2,234) (3,485) (3,410) (3,214) Deferred income taxes...................................... (3,920) (6,503) (13,700) (10,229) Change in deferred rent.................................... 1,714 2,461 3,969 4,522 Change in other liabilities ............................... 2,790 2,009 3,761 2,561 Income tax benefits credited to equity..................... 4,496 9,177 13,788 13,704 Other, net................................................. 1,726 556 7,693 (1,776) ---------- ---------- ---------- ---------- Net cash provided by operating activities................ $ 42,051 $ 113,890 $ 247,102 $ 226,747 ---------- ---------- ---------- ---------- Cash flows--investing activities Sales (purchases) of short term investments.................. 90,000 -- (10,000) -- Purchases of land, buildings and equipment................... (85,071) (84,117) (166,172) (146,782) Proceeds from disposal of land, buildings and equipment ..... 6,254 4,020 6,254 5,204 Increase in other assets..................................... (3,446) (1,931) (6,022) (2,250) ---------- ---------- ---------- ---------- Net cash provided by (used in) investing activities...... $ 7,737 $ (82,028) $(175,940) $(143,828) ---------- ---------- ---------- ---------- Cash flows--financing activities Proceeds from issuance of common stock....................... 13,013 20,797 32,028 30,312 Dividends paid............................................... (29,854) (6,251) (29,854) (6,251) Purchases of treasury stock.................................. (55,132) (6,780) (188,270) (68,743) Decrease in short-term debt.................................. -- (17,800) -- (14,500) Proceeds from issuance of long-term debt..................... -- -- 294,669 -- ESOP note receivable repayment............................... 1,187 240 2,175 990 Repayment of long-term debt.................................. (151,187) (240) (152,175) (990) ---------- ---------- ---------- ---------- Net cash used in financing activities.................... $(221,973) $ (10,034) $ (41,427) $(59,182) ---------- ---------- ---------- ---------- (Decrease) increase in cash and cash equivalents................ (172,185) 21,828 29,735 23,737 Cash and cash equivalents - beginning of period................. 244,721 38,603 42,801 36,694 ---------- ---------- ---------- ---------- Cash and cash equivalents - end of period....................... $ 72,536 $ 60,431 $ 72,536 $ 60,431 ========== ========== ========== ========== Cash flow from changes in current assets and liabilities Receivables.................................................. 2,003 (5,383) (1,556) (647) Inventories.................................................. (21,636) (18,452) (11,909) (37,660) Prepaid expenses and other current assets.................... 3,283 5,049 (3,787) 2,562 Accounts payable............................................. (19,224) (2,899) 18,570 (12,825) Accrued payroll.............................................. 3,332 3,173 (11,965) (10,727) Accrued income taxes......................................... (46,779) 13,407 (8,411) 42,742 Other accrued taxes.......................................... (5,567) (4,190) (2,267) (2,357) Unearned revenues............................................ 4,525 6,063 (7,386) (4,359) Other current liabilities.................................... 1,938 13,163 5,540 18,312 ---------- ---------- ----------- ---------- Change in current assets and liabilities................. $ (78,125) $ 9,931 $ (23,171) $ (4,959) ========== ========== =========== ========== - ---------------------------------------------------------------------------------------------------------------------------- </TABLE> See accompanying notes to consolidated financial statements. 6
DARDEN RESTAURANTS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollar amounts in thousands, except per share data) Note 1. Background Darden Restaurants, Inc. ("we, "our" or the "Company") owns and operates casual dining restaurants in the United States and Canada under the trade names Red Lobster(R), Olive Garden(R), Bahama Breeze(R), Smokey Bones Barbeque & Grill(R) and Seasons 52(R). We have prepared these consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). They do not include certain information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. However, in the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. Operating results for the quarter and six months ended November 27, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending May 28, 2006. These statements should be read in conjunction with the consolidated financial statements and related notes to consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 29, 2005. The accounting policies used in preparing these consolidated financial statements are the same as those described in our Form 10-K. The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Note 2. Consolidated Statements of Cash Flows During the quarter and six months ended November 27, 2005, we paid $10,798 and $18,415, respectively, for interest (net of amounts capitalized) and $71,888 and $75,957, respectively, for income taxes. Interest income of $1,332 and $2,484 associated with our cash and cash equivalents and short-term investments was recognized in earnings as a component of interest, net, during the quarter and six months ended November 27, 2005. During the quarter and six months ended November 28, 2004, we paid $12,584 and $20,022, respectively, for interest (net of amounts capitalized) and $3,657 and $10,357, respectively, for income taxes. Interest income of $328 and $537 associated with our cash and cash equivalents was recognized in earnings as a component of interest, net, during the quarter and six months ended November 28, 2004. Note 3. Stock-Based Compensation Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," encourages the use of a fair-value method of accounting for stock-based awards under which the fair value of stock options is determined on the date of grant and expensed over the vesting period. As allowed by SFAS No. 123, we have elected to account for our stock-based compensation plans under an intrinsic value method that requires compensation expense to be recorded only if, on the date of grant, the current market price of our common stock exceeds the exercise price the employee must pay for the stock. Our policy is to grant stock options at the fair market value of our underlying stock at the date of grant. Accordingly, no compensation expense has been recognized for stock options granted under any of our stock plans because the exercise price of all options granted was equal to the current market value of our stock on the grant date. Had we determined compensation expense for 7
our stock options based on the fair value at the grant date as prescribed under SFAS No. 123, our net earnings and net earnings per share would have been reduced to the pro forma amounts indicated below: <TABLE> <CAPTION> Quarter Ended Six Months Ended - ----------------------------------------------------------------------------------------------------------------- November 27, November 28, November 27, November 28, 2005 2004 2005 2004 - ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net earnings, as reported $ 55,057 $ 42,975 $ 140,571 $ 113,987 Add: Stock-based compensation expense included in reported net earnings, net of related tax effects 1,676 1,569 2,552 2,629 Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (5,018) (5,584) (10,424) (10,612) ---------------------------------------------------------------- $ 51,715 $ 38,960 $ 132,699 $ 106,004 ================================================================ Basic net earnings per share As reported $ 0.37 $ 0.27 $ 0.93 $ 0.73 Pro forma $ 0.35 $ 0.25 $ 0.88 $ 0.67 Diluted net earnings per share As reported $ 0.35 $ 0.26 $ 0.89 $ 0.70 Pro forma $ 0.33 $ 0.24 $ 0.84 $ 0.65 ================================================================================================================= </TABLE> Note 4. Short-Term Investments Short-term investments consist of investment grade auction rate securities, which have been classified as available-for-sale and reported at fair value. Interest rates for our investments in auction rate securities are reset through an auction process at predetermined periods ranging from 28 to 35 days. Despite the long-term nature of their stated contractual maturities, there is a readily liquid market for these securities and failed auctions rarely occur. Due to the reset feature and their carrying value equaling their fair value, there are no gross realized and unrealized gains or losses from these short-term investments. As of November 27, 2005 and May 29, 2005, we held approximately $10,000 and $0, respectively, in short-term investments. Note 5. Long-Term Debt On July 29, 2005, we filed a registration statement with the SEC to register an additional $475,000 of debt securities using a shelf registration process as well as to carry forward the $125,000 of debt securities available under our prior registration statement. Under this registration statement, which became effective on August 5, 2005, we may offer, from time to time, up to $600,000 of our debt securities. On August 12, 2005, we issued $150,000 of unsecured 4.875 percent senior notes due in August 2010 and $150,000 of unsecured 6.000 percent senior notes due in August 2035 under the registration statement. Discount and issuance costs, which were $2,430 and $2,901, respectively, are being amortized over the terms of the senior notes using the effective interest rate method. A portion of the proceeds from these issuances was used to repay at maturity our outstanding $150,000 of 8.375 percent senior notes on September 15, 2005. We intend to use the remaining proceeds from the issuance to repay at maturity our outstanding $150,000 of 6.375 percent notes due February 1, 2006. We also maintain a credit facility, dated August 16, 2005, with a consortium of banks under which we can borrow up to $500,000. As part of this credit facility, we may request issuance of up to $100,000 in letters of credit. The credit facility allows us to borrow at interest rates that vary based on a spread over (i) LIBOR or (ii) a base rate that is the higher of the prime rate or one-half of one percent above the federal funds rate, at our option. The interest rate spread over LIBOR is determined by our debt rating. We may also request that loans be made at interest rates offered by one or more of the banks, which may vary from the LIBOR or base rate. The credit facility supports our commercial paper borrowing program and expires on August 15, 2010. We are required to pay a facility fee of 10.0 basis points per annum on the average daily amount of loan commitments by the consortium. The amount of interest and annual facility fee are subject to change based on our maintenance of certain debt ratings and financial ratios, such as maximum debt to capital ratios. Advances under the credit facility are unsecured. As of November 27, 2005 and May 29, 2005, no borrowings were outstanding. 8
Note 6. Net Earnings per Share Outstanding stock options and restricted stock granted by us represent the only dilutive effect reflected in diluted weighted average shares outstanding. Options and restricted stock do not impact the numerator of the diluted net earnings per share computation. Options to purchase 1,953,883 and 2,674,182 shares of common stock were excluded from the calculation of diluted net earnings per share for the quarters ended November 27, 2005 and November 28, 2004, respectively, because their exercise prices exceeded the average market price of common shares for the period. Options to purchase 1,941,383 and 3,539,251 shares of common stock were excluded from the calculation of diluted net earnings per share for the six months ended November 27, 2005 and November 28, 2004, respectively, for the same reason. Note 7. Stockholders' Equity Pursuant to the authorization of our Board of Directors to repurchase up to 137,400,000 shares in accordance with applicable securities regulations, we repurchased 1,785,181 and 5,839,255 shares of our common stock for $55,132 and $188,270 during the quarter and six months ended November 27, 2005, respectively, resulting in a cumulative repurchase of 126,424,126 shares as of November 27, 2005. Note 8. Food and Beverage Costs Food and beverage costs include inventory, warehousing and related purchasing and distribution costs. Vendor allowances received in connection with the purchase of a vendor's products are recognized as a reduction of the related food and beverage costs as earned. Advance payments are made by the vendors based on estimates of volume to be purchased from the vendors and the terms of the agreement. As we make purchases from the vendors each period, we recognize the pro rata portion of allowances earned as a reduction of food and beverage costs for that period. Differences between estimated and actual purchases are settled in accordance with the terms of the agreements. Vendor agreements are generally for a period of one year or more and payments received are initially recorded as long-term liabilities. Amounts which are expected to be earned within one year are recorded as a current liability. Note 9. Derivative Instruments and Hedging Activities During the first quarter of fiscal 2006 and fiscal 2005, we entered into equity forward contracts to hedge the risk of changes in future cash flows associated with the unvested unrecognized Darden stock units granted during the first quarter of fiscal 2006 and fiscal 2005. The equity forward contracts will be settled at the end of the vesting periods of their underlying Darden stock units, which range between four and five years. The equity forward contracts, which are indexed to 330,000 shares of our common stock, have an $8,264 notional amount and can only be net settled in cash. The equity forward contracts are used to hedge the variability in cash flows associated with the unvested unrecognized Darden stock units. To the extent the equity forward contracts are effective in offsetting the variability of the hedged cash flows, changes in the fair value of the equity forward contracts are not included in current earnings but are reported as accumulated other comprehensive income (loss). A deferred gain of $2,693 related to the equity forward contracts was recognized in accumulated other comprehensive income (loss) at November 27, 2005. As the Darden stock units vest, we will effectively de-designate that portion of the equity forward contract that no longer qualifies for hedge accounting, and changes in fair value associated with that portion of the equity forward contract will be recognized in current earnings. A gain of $420 and $102 was recognized in earnings as a component of restaurant labor during the quarters ended November 27, 2005 and November 28, 2004, respectively. A gain of $511 and $116 was recognized in earnings as a component of restaurant labor during the six months ended November 27, 2005 and November 28, 2004, respectively. 9
During fiscal 2005 and fiscal 2004, we entered into interest rate swap agreements ("swaps") to hedge the risk of changes in interest rates on the cost of a future issuance of fixed-rate debt. The swaps, which had a $100,000 notional principal amount of indebtedness, were used to hedge a portion of the interest payments associated with $150,000 of unsecured 4.875 percent senior notes due in August 2010, which were issued in August 2005. The interest rate swaps were settled at the time of the related debt issuance with a net loss of $1,177 being recognized in accumulated other comprehensive income (loss). The net loss on the interest rate swaps is being amortized into earnings as an adjustment to interest expense over the same period in which the related interest costs on the new debt issuance are being recognized in earnings. A loss of $59 was recognized in earnings during the quarter ended November 27, 2005 as an adjustment to interest expense. Note 10. Retirement Plans Components of net periodic benefit cost are as follows: <TABLE> <CAPTION> Defined Benefit Plans Postretirement Benefit Plan - ----------------------------------------------------------------------------------------------------------------------- Quarter Ended Quarter Ended November November 28, November 27, November 28, 27, 2005 2004 2005 2004 - ----------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Service cost $ 1,321 $ 1,217 $ 159 $ 176 Interest cost 2,016 1,829 233 251 Expected return on plan assets (3,264) (3,210) -- -- Amortization of unrecognized prior service cost 21 (87) -- -- Recognized net actuarial loss 1,374 1,248 49 86 - ----------------------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 1,468 $ 997 $ 441 $ 513 ======================================================================================================================= Defined Benefit Plans Postretirement Benefit Plan - ----------------------------------------------------------------------------------------------------------------------- Six Months Ended Six Months Ended November November 28, November 27, November 28, 27, 2005 2004 2005 2004 - ----------------------------------------------------------------------------------------------------------------------- Service cost $ 2,621 $ 2,434 $ 340 $ 350 Interest cost 4,032 3,657 466 502 Expected return on plan assets (6,534) (6,420) -- -- Amortization of unrecognized prior service cost 42 (174) -- -- Recognized net actuarial loss 2,748 2,496 98 173 - ----------------------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 2,909 $ 1,993 $ 904 $ 1,025 ======================================================================================================================= </TABLE> Note 11. Commitments and Contingencies As collateral for performance on other contracts and as credit guarantees to banks and insurers, we are contingently liable pursuant to guarantees of subsidiary obligations under standby letters of credit. As of November 27, 2005, and May 29, 2005, we had $64,556 and $72,677, respectively, of standby letters of credit related to workers' compensation and general liabilities accrued in our consolidated financial statements. As of November 27, 2005 and May 29, 2005, we also had $14,377 and $13,829, respectively, of standby letters of credit related to contractual operating lease obligations and other payments. All standby letters of credit are renewable annually. As of November 27, 2005 and May 29, 2005, we had $1,519 and $1,768, respectively, of guarantees associated with properties that have been assigned to third parties. These amounts represent the maximum potential amount of future payments under the guarantees. The fair value of these potential payments, discounted at our pre-tax cost of capital, at November 27, 2005 and May 29, 2005 amounted to $1,212 and $1,395, respectively. We have not accrued for the guarantees, as we believe the likelihood of the third parties defaulting on the assignment agreements is improbable. In the event of default by a third party, the indemnity and default clauses in our assignment agreements govern our ability to pursue and recover from the third party for damages incurred as a result of its default. We do not hold any third-party assets as collateral related to these assignment agreements, except to the extent the assignment allows us to repossess the building and personal property. The guarantees expire over their respective lease terms, which range from fiscal 2007 through fiscal 2012. 10
We are subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of our business. A number of these lawsuits, proceedings and claims may exist at any given time. These matters typically involve claims from guests, employees and others related to operational issues common to the restaurant industry and can also involve infringement of, or challenges to, our trademarks. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, we believe that the final disposition of the lawsuits, proceedings and claims in which we are currently involved, either individually or in the aggregate, will not have a material adverse effect on our financial position, results of operations or liquidity. Like other restaurant companies and retail employers, we have been faced in a few states with allegations of purported class-wide wage and hour violations. The following is a brief description of the more significant of these matters. In view of the inherent uncertainties of litigation, the outcome of any unresolved matter described below cannot be predicted at this time, nor can the amount of any potential loss be reasonably estimated. In March 2003 and March 2002, two purported class action lawsuits were brought against us in the Superior Court of Orange County, California by three current and former hourly restaurant employees alleging violations of California labor laws with respect to providing meal and rest breaks. Although we continue to believe we provided the required meal and rest breaks to our employees, to avoid potentially costly and protracted litigation, we agreed during the second quarter of fiscal 2005 to settle both lawsuits and a similar case filed in Sacramento County for approximately $9,500. Terms of the settlement, which do not include any admission of liability by us, have received preliminary judicial approval, and claims administration is underway. During the quarter ended November 27, 2005, we paid $3,720 towards the settlement of these claims. The remaining $5,780 was paid in December 2005 and is included in other current liabilities at November 27, 2005. In August 2003, three former employees in Washington filed a similar purported class action in Washington State Superior Court in Spokane County alleging violations of Washington labor laws with respect to providing rest breaks. The Court stayed the action and ordered the plaintiffs into our mandatory arbitration program. The plaintiffs' motion for reconsideration was not granted; their appeal of the denial of reconsideration was also not granted, and plaintiffs subsequently filed a demand for arbitration. We believe we provided the required meal and rest breaks to our employees, and we intend to vigorously defend our position in this case. Beginning in 2002, a total of five purported class action lawsuits were filed in Superior Courts of California (two each in Los Angeles County and Orange County, and one in Sacramento County) in which the plaintiffs allege that they and other current and former service managers, beverage and hospitality managers and culinary managers were improperly classified as exempt employees under California labor laws. The plaintiffs seek unpaid overtime wages and penalties. Two of the cases have been removed to arbitration under our mandatory arbitration program, one has been stayed to allow consideration of judicial coordination with the other cases, one is proceeding as an individual claim, and one remains a purported class action litigation matter. We believe we properly classified these employees as exempt under California law, and we intend to vigorously defend against all claims in these lawsuits. Note 12. Future Application of Accounting Standards In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs," which clarifies the accounting for abnormal amounts of idle facilities expense, freight, handling costs and wasted material. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a material impact on our consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-Monetary Assets." SFAS No. 153 eliminates the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not believe the adoption of SFAS No. 153 will have a material impact on our consolidated financial statements. 11
In December 2004, the FASB issued SFAS No. 123 (Revised), "Share-Based Payment." SFAS No. 123R revises SFAS No. 123, "Accounting for Stock-Based Compensation" and generally requires the cost associated with employee services received in exchange for an award of equity instruments to be measured based on the grant-date fair value of the award and recognized in the financial statements over the period during which employees are required to provide service in exchange for the award. SFAS No. 123R also provides guidance on how to determine the grant-date fair value for awards of equity instruments as well as alternative methods of adopting its requirements. SFAS No. 123R is effective for annual reporting periods beginning after June 15, 2005. As disclosed in Note 3, based on the current assumptions and calculations used, had we recognized compensation expense based on the fair value of awards of equity instruments, net earnings would have been reduced by approximately $3,342 and $7,872 for the quarter and six months ended November 27, 2005, respectively, and $4,015 and $7,983 for the quarter and six months ended November 28, 2004, respectively. We have not yet determined the method of adoption or the effect of adopting SFAS No. 123R and have not determined whether the adoption will result in future amounts similar to the current pro forma disclosures under SFAS No. 123. In June 2005, the FASB's Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 05-6, "Determining the Amortization Period for Leasehold Improvements" ("EITF 05-6"). EITF 05-6 requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The adoption of EITF 05-6 did not have a material impact on our consolidated financial statements. In October 2005, the Financial Accounting Standards Board issued Staff Position No. 13-1, "Accounting for Rental Costs Incurred During a Construction Period" ("FSP No. 13-1"). FSP No. 13-1 is effective for the first reporting period beginning after December 15, 2005 and requires that rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense. Adoption of FSP No. 13-1 will not have a material impact on our financial statements as our existing accounting policies are in compliance with FSP No. 13-1. 12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The discussion and analysis below for the Company should be read in conjunction with the financial statements and the notes to such financial statements included elsewhere in this Form 10-Q. The following table sets forth selected operating data as a percent of sales for the periods indicated. All information is derived from the consolidated statements of earnings for the quarters and six months ended November 27, 2005 and November 28, 2004. <TABLE> <CAPTION> Quarter Ended Six Months Ended ---------------------------------------------------------------------------------------------------------------------- November 27, November 28, November 27, November 28, 2005 2004 2005 2004 ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Sales .................................................... 100.0% 100.0% 100.0% 100.0% Costs and expenses: Cost of sales: Food and beverage.................................... 29.4 29.9 29.6 30.3 Restaurant labor..................................... 33.3 32.6 32.6 32.2 Restaurant expenses.................................. 16.2 16.5 15.7 15.8 ----- ------ ------ ----- Total cost of sales, excluding restaurant depreciation and amortization of 3.8%, 4.0%, 3.7% and 3.9%, respectively............... 78.9% 79.0% 77.9% 78.3% Selling, general and administrative.................... 10.0 10.6 9.7 9.8 Depreciation and amortization.......................... 4.1 4.3 4.0 4.2 Interest, net.......................................... 0.9 0.9 0.8 0.9 ----- ------ ------ ----- Total costs and expenses......................... 93.9% 94.8% 92.4% 93.2% ----- ------ ------ ----- Earnings before income taxes.............................. 6.1 5.2 7.6 6.8 Income taxes.............................................. (1.9) (1.7) (2.5) (2.3) ----- ------ ------ ----- Net earnings.............................................. 4.2% 3.5% 5.1% 4.5% ===== ====== ====== ===== ---------------------------------------------------------------------------------------------------------------------- </TABLE> OVERVIEW OF OPERATIONS Our sales were $1.33 billion and $2.73 billion for the second quarter and first six months of fiscal 2006 compared to $1.23 billion and $2.51 billion for the second quarter and first six months of fiscal 2005. The 7.8 percent and 9.0 percent increases in sales for the second quarter and first six months of fiscal 2006, respectively, were driven primarily by increased U.S. same-restaurant sales at Olive Garden and Red Lobster and a net increase of 55 company-owned restaurants since the second quarter of fiscal 2005. For the second quarter of fiscal 2006, our net earnings were $55 million compared to $43 million for the second quarter of fiscal 2005, a 28.1 percent increase, and our diluted net earnings per share were $0.35 for the second quarter of fiscal 2006 compared to $0.26 for the second quarter of fiscal 2005, a 34.6 percent increase. For the first six months of fiscal 2006, our net earnings were $141 million compared to $114 million for the first six months of fiscal 2005, a 23.3 percent increase, and our diluted net earnings per share were $0.89 for the first six months of fiscal 2006 compared to $0.70 for the first six months of fiscal 2005, a 27.1 percent increase. Olive Garden reported its 45th consecutive quarter of U.S. same-restaurant sales growth during the second quarter of fiscal 2006 with a 6.4 percent increase. Olive Garden continues to focus on providing an excellent guest experience, and laying the foundation for accelerated new restaurant growth. Red Lobster's U.S. same-restaurant sales for the second quarter of fiscal 2006 increased for the fifth consecutive quarter with a 2.7 percent increase. During the second quarter of fiscal 2006, Red Lobster continued to focus on its "Simply Great" operating discipline, which has helped improve its consistency of execution while also reducing unnecessary costs. As a result, Red Lobster has improved its guest satisfaction results to record levels and increased same-restaurant sales. Bahama Breeze's same-restaurant sales increased 1.9 percent in the second quarter of fiscal 2006 while it continues to focus on improving the guest experience and introducing several new approachable but distinctive dishes. Smokey Bones same-restaurant sales decreased 8.5 percent in the second quarter of fiscal 2006. Smokey Bones operated 34 more 13
restaurants than the prior year's second quarter, including seven that were opened during the second quarter of fiscal 2006. Smokey Bones continues to focus on broadening its appeal through menu enhancements and increasing guest frequency while lowering its cost of sales. In addition, recent softening of sales at Smokey Bones has lead us to reevaluate our new restaurant opening strategy. We expect to focus future openings in the geographic areas where Smokey Bones has demonstrated business strength in order to ensure an appropriate return on capital. We also expect to slow the pace of new restaurant openings for Smokey Bones from 25 to 30 in fiscal 2006 to approximately 10 to 15 new restaurants in fiscal 2007. Hurricanes Katrina and Rita, which occurred in the second quarter of fiscal 2006, had a minimal direct effect on our fiscal second quarter 2006 sales and net earnings. There are currently two restaurants (one Olive Garden and one Red Lobster) that are closed indefinitely, and one Red Lobster that is closed temporarily, as a result of Hurricane Katrina. Decisions regarding rebuilding and reopening are pending clean-up and recovery efforts in Louisiana and Mississippi. SALES Sales were $1.33 billion and $1.23 billion for the quarters ended November 27, 2005 and November 28, 2004, respectively. The 7.8 percent increase in sales for the second quarter of fiscal 2006 was primarily due to increased U.S. same-restaurant sales at Olive Garden and Red Lobster and a net increase of 55 company-owned restaurants since the second quarter of fiscal 2005. Red Lobster sales of $589 million were 3.4 percent above last year's second quarter, which resulted primarily from a 2.7 percent increase in U.S. same-restaurant sales. The increase in U.S. same-restaurant sales resulted primarily from a 1.4 percent increase in same-restaurant guest counts and a 1.3 percent increase in average check. Olive Garden's sales of $618 million were 9.6 percent above last year's second quarter, driven primarily by a 6.4 percent increase in U.S. same-restaurant sales and its 21 net new restaurants in operation since the second quarter of last year. Olive Garden achieved its 45th consecutive quarter of U.S. same-restaurant sales growth primarily as a result of a 4.7 percent increase in same-restaurant guest counts and a 1.7 percent increase in average check. Bahama Breeze sales of $36 million were 1.9 percent above last year's second quarter, primarily as a result of higher same-restaurant guest counts. Smokey Bones sales of $77 million were 31 percent above last year's second quarter primarily as a result of its 34 net new restaurants in operation since the second quarter of last year. Same restaurant sales decreased 8.5 percent compared the second quarter of last year. Sales were $2.73 billion and $2.51 billion for the six months ended November 27, 2005 and November 28, 2004, respectively. The 9.0 percent increase in sales for the first six months of fiscal 2006 was primarily due to increased U.S. same-restaurant sales at Olive Garden and Red Lobster and a net increase of 55 company-owned restaurants since the second quarter of fiscal 2005. Red Lobster sales of $1.22 billion were 5.1 percent above last year, which resulted primarily from a 4.2 percent increase in U.S. same-restaurant sales. The increase in U.S. same-restaurant sales resulted primarily from a 2.2 percent increase in same-restaurant guest counts and a 2.0 percent increase in average check. Olive Garden's sales of $1.26 billion were 10.2 percent above last year, driven primarily by a 7.0 percent increase in U.S. same-restaurant sales and its 21 net new restaurants in operation since the second quarter of last year. The increase in U.S. same-restaurant sales resulted primarily from a 4.9 percent increase in same-restaurant guest counts and a 2.1 percent increase in average check. Bahama Breeze sales of $82 million were 0.4 percent above last year. Smokey Bones sales of $159 million were 38.5 percent above last year primarily as a result of its 34 net new restaurants in operation since the second quarter of last year. COSTS AND EXPENSES Total costs and expenses were $1.24 billion and $1.17 billion for the quarters ended November 27, 2005 and November 28, 2004, respectively. As a percent of sales, total costs and expenses decreased from 94.8 percent in the second quarter of fiscal 2005 to 93.9 percent in the second quarter of fiscal 2006. Food and beverage costs increased $22 million, or 5.9 percent, from $368 million to $390 million in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005. As a percent of sales, food and beverage costs decreased in the second quarter of fiscal 2006 primarily as a result of lower seafood costs and cost savings initiatives. Food and beverage costs, as a percent of sales, also decreased as a result of the larger contribution by Olive Garden, which has historically had lower food and beverage costs, to our overall sales and operating results. Restaurant labor increased $40 million, or 10 percent, from $401 million to $441 million in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005. As a percent of sales, restaurant labor increased in the second quarter of fiscal 2006 primarily as a result of an increase in wage rates and benefit costs and 14
higher restaurant-level bonuses, which were partially offset by increased sales leverage at Olive Garden and Red Lobster. Restaurant labor, as a percent of sales, also increased as a result of the larger contribution by Olive Garden, which has historically had higher restaurant labor costs, to our overall sales and operating results. Restaurant expenses (which include lease, property tax, credit card, utility, workers' compensation, insurance, new restaurant pre-opening and other restaurant-level operating expenses) increased $13 million, or 6.3 percent, from $202 million to $215 million in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005. As a percent of sales, restaurant expenses decreased in the second quarter of fiscal 2006 primarily as a result of increased sales leverage at Olive Garden and Red Lobster and lower workers' compensation and general liability expenses, which were partially offset by higher utility and pre-opening expenses at Olive Garden and Red Lobster. The decrease in our workers' compensation and general liability expenses resulted primarily from safety initiatives which have continued to provide reductions in the frequency rate of claims. Selling, general and administrative expenses increased $1 million, or 1.1 percent, from $131 million to $132 million in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005. As a percent of sales, selling, general and administrative expenses decreased in the second quarter of fiscal 2006 primarily as a result of increased sales leverage at Olive Garden and Red Lobster. Depreciation and amortization expense increased $2 million, or 3.0 percent, from $53 million to $55 million in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005. As a percent of sales, depreciation and amortization expense decreased in the second quarter of fiscal 2006 primarily as a result of increased sales leverage at Olive Garden and Red Lobster, which was partially offset by new restaurant activity. Net interest expense in the second quarter of fiscal 2006 was comparable to the second quarter of fiscal 2005. Although interest expense increased as a result of the issuance of additional long-term debt in August 2005, this increase was offset by the interest income associated with the investment of proceeds from the issuance of the long-term debt. Total costs and expenses were $2.53 billion and $2.34 billion for the six months ended November 27, 2005 and November 28, 2004, respectively. As a percent of sales, total costs and expenses decreased from 93.2 percent for the first six months of fiscal 2005 to 92.4 percent for the first six months of fiscal 2006. Food and beverage costs increased $49 million, or 6.5 percent, from $759 million to $809 million in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. As a percent of sales, food and beverage costs decreased in the first six months of fiscal 2006 primarily as a result of cost savings initiatives. Food and beverage costs, as a percent of sales, also decreased as a result of the larger contribution by Olive Garden, which has historically had lower food and beverage costs, to our overall sales and operating results. Restaurant labor increased $84 million, or 10.4 percent, from $807 million to $890 million in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. As a percent of sales, restaurant labor increased in the first six months of fiscal 2006 primarily as a result of an increase in wage rates and higher restaurant-level bonuses, which was partially offset by increased sales leverage at Olive Garden and Red Lobster. Restaurant labor, as a percent of sales, also increased as a result of the larger contribution by Olive Garden, which has historically had higher restaurant labor costs, to our overall sales and operating results. Restaurant expenses increased $32 million, or 8.2 percent, from $397 million to $430 million in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. As a percent of sales, restaurant expenses decreased in the first six months of fiscal 2006 primarily as a result of increased sales leverage at Olive Garden and Red Lobster and lower workers' compensation and general liability expenses, which were partially offset by higher utility and pre-opening expenses at Olive Garden and Red Lobster. Selling, general and administrative expenses increased $20 million, or 8.1 percent, from $245 million to $265 million in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. As a percent of sales, selling, general and administrative expenses decreased in the first six months of fiscal 2006 primarily as a result of increased sales leverage at Olive Garden and Red Lobster. Depreciation and amortization expense increased $3 million, or 2.8 percent, from $106 million to $109 million in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. As a percent of sales, depreciation and amortization expense decreased in the first six months of fiscal 2006 primarily as a result of increased sales leverage at Olive Garden and Red Lobster, which was partially offset by new restaurant activity. 15
Net interest expense increased $1 million, or 2.9 percent, from $22 million to $23 million in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. As a percent of sales, net interest expense decreased in the first six months of fiscal 2006 primarily as a result increased sales leverage at Olive Garden and Red Lobster. INCOME TAXES The effective income tax rate for the second quarter and first six months of fiscal 2006 was 31.9 percent and 32.7 percent, respectively, compared to an effective income tax rate of 32.2 percent and 33.5 in the second quarter and first six months of fiscal 2005, respectively. The rate decrease in fiscal 2006 was primarily due to an increase in FICA tax credits for employee reported tips that we expect to receive for fiscal 2006. NET EARNINGS AND NET EARNINGS PER SHARE For the second quarter of fiscal 2006, our net earnings were $55 million compared to $43 million in the second quarter of fiscal 2005, a 28.1 percent increase, and our diluted net earnings per share were $0.35 compared to $0.26 in the second quarter of fiscal 2005, a 34.6 percent increase. At Red Lobster, increased sales and lower food and beverage costs, restaurant expenses, selling, general and administrative expenses and depreciation expenses as a percent of sales more than offset higher restaurant labor costs as a percent of sales. As a result, Red Lobster had a strong double-digit operating profit increase in the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005. At Olive Garden, increased sales and lower food and beverage costs, selling, general and administrative expenses and depreciation expenses as a percent of sales more than offset increased restaurant labor costs and restaurant expenses as a percent of sales, resulting in record second quarter operating profit for Olive Garden in fiscal 2006 and a double-digit operating profit increase over the same period in fiscal 2005. The increase in both our net earnings and diluted net earnings per share for the second quarter of fiscal 2006 was primarily due to increased U.S. same-restaurant sales at Olive Garden and Red Lobster, new restaurant growth and decreases in our consolidated food and beverage costs, restaurant expenses, selling, general and administrative expenses and depreciation expenses as a percent of sales, which more than offset increased restaurant labor expenses as a percent of sales. For the first six months of fiscal 2006, our net earnings were $141 million compared to $114 million for the first six months of fiscal 2005, a 23.3 percent increase, and our diluted net earnings per share were $0.89 compared to $0.70 in the first six months of fiscal 2005, a 27.1 percent increase. At Red Lobster, increased sales and lower food and beverage costs, restaurant expenses, selling, general and administrative expenses and depreciation expenses as a percent of sales more than offset higher restaurant labor expenses as a percent of sales. As a result, Red Lobster had a strong double-digit operating profit increase in the first six months of fiscal 2006 compared to the first six months of fiscal 2005. At Olive Garden, increased sales and lower food and beverage costs, restaurant expenses and depreciation expenses as a percent of sales more than offset increased restaurant labor costs, and selling, general and administrative expenses as a percent of sales, resulting in a double-digit operating profit increase over the first six months of fiscal 2005. The increase in both our net earnings and diluted net earnings per share for the first six months of fiscal 2006 was primarily due to increased U.S. same-restaurant sales at Olive Garden and Red Lobster, new restaurant growth and decreases in our consolidated food and beverage costs, restaurant expenses, selling, general and administrative expenses and depreciation expenses as a percent of sales, which more than offset increased restaurant labor expenses as a percent of sales. SEASONALITY Our sales volumes fluctuate seasonally. During fiscal 2005, our sales were highest in the spring and winter, followed by the summer, and lowest in the fall. During fiscal 2004 and 2003, our sales were highest in the spring, lowest in the fall, and comparable during winter and summer. Holidays, severe weather and similar conditions may impact sales volumes seasonally in some operating regions. Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year. 16
NUMBER OF RESTAURANTS The following table details the number of restaurants open at the end of the second quarter of fiscal 2006, compared with the number open at the end of fiscal 2005 and the end of the second quarter of fiscal 2005. <TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------- November 27, 2005 May 29, 2005 November 28, 2004 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Red Lobster - USA.................. 647 648 649 Red Lobster - Canada............... 31 31 31 ------ ------ ------ Total......................... 678 679 680 ------ ------ ------ Olive Garden - USA................. 562 557 541 Olive Garden - Canada.............. 6 6 6 ------- ------ ------ Total......................... 568 563 547 ------- ------ ------ Bahama Breeze...................... 32 32 32 Smokey Bones ...................... 117 104 83 Seasons 52......................... 3 3 1 ------- ------ ------ Total......................... 1,398 1,381 1,343 ======= ====== ====== - -------------------------------------------------------------------------------------------------------------------- </TABLE> 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, to pay dividends 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 five 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. Our commercial paper program serves as our primary source of short-term financing. As of November 27, 2005, no commercial paper was outstanding under the program. To support our commercial paper program, we have a credit facility under a Credit Agreement dated August 16, 2005, with a consortium of banks, under which we can borrow up to $500 million. As part of this credit facility, we may request issuance of up to $100 million in letters of credit. The borrowings and letters of credit obtained under the Credit Agreement may be denominated in U.S. dollars or other currencies approved by the banks. The Credit Agreement allows us to borrow at interest rates that vary based on a spread over (i) LIBOR or (ii) a base rate that is the higher of the prime rate or one-half of one percent above the federal funds rate, at our option. The interest rate spread over LIBOR is determined by our debt rating. We may also request that loans be made at interest rates offered by one or more of the banks, which may vary from the LIBOR or base rate. The credit facility expires on August 15, 2010, and contains various restrictive covenants, including a leverage test that requires us to maintain a ratio of consolidated total debt to consolidated total capitalization of less than 0.65 to 1.00 and a limitation on secured debt and debt owed by subsidiaries, subject to certain exceptions, of 10 percent of our consolidated tangible net worth. The credit facility does not, however, contain a prohibition on borrowing in the event of a ratings downgrade or a Material Adverse Effect, as defined in the Credit Agreement. None of these covenants is expected to limit our liquidity or capital resources. As of November 27, 2005, we were in compliance with all covenants under the Credit Agreement. At November 27, 2005, our long-term debt consisted principally of: (1) $150 million of unsecured 5.75 percent medium-term notes due in March 2007, (2) $75 million of unsecured 7.45 percent medium-term notes due in April 2011, (3) $100 million of unsecured 7.125 percent debentures due in February 2016, (4) $150 million of unsecured 4.875 percent senior notes due in August 2010, (5) $150 million of unsecured 6.000 percent senior notes due in August 2035 and (6) an unsecured, variable rate $24 million commercial bank loan due in December 2018 that is used to support two loans from us to the Employee Stock Ownership Plan portion of the Darden Savings Plan. We also have $150 million of unsecured 6.375 percent notes due in February 2006 included in current liabilities at November 27, 2005. In September 2005, we used a portion of the proceeds from our issuance of the 4.875 percent and 6.000 percent senior notes, which were issued in August 2005, to repay $150 million of unsecured 8.375 percent senior notes at maturity. We intend to use the remaining proceeds from the senior notes issued in August 2005 to repay at maturity the $150 million of unsecured 6.375 percent notes due February 1, 2006. The proceeds from the issuance of the senior notes in August 2005 and the repayment of the $150 million of senior notes in September 2005 17
are included in net cash flows used in financing activities for the quarter and six months ended November 27, 2005. Through a shelf registration on file with the SEC, we may issue up to an additional $300 million of unsecured debt securities from time to time. The debt securities may bear interest at either fixed or floating rates and will have such other terms as determined at the time of any issuance. Our Board of Directors has authorized us to repurchase up to an aggregate of 137.4 million shares of our common stock. Net cash flows used in financing activities included our repurchase of 1.8 million shares of our common stock for $55 million in the second quarter of fiscal 2006, compared to 0.3 million shares for $7 million in the second quarter of fiscal 2005. For the first six months of fiscal 2006, net cash flows used by financing activities included our repurchase of 5.8 million shares of our common stock for $188 million compared to 3.2 million shares for $69 million for the first six months of 2005. As of November 27, 2005, we have repurchased a total of 126.4 million shares of our common stock. The repurchased common stock is reflected as a reduction of stockholders' equity. Net cash flows provided by (used in) investing activities included capital expenditures incurred principally for building new restaurants, replacing equipment and remodeling existing restaurants. Capital expenditures were $85 million and $166 million in the second quarter and first six months of fiscal 2006, respectively, compared to $84 million and $147 million in the second quarter and first six months of fiscal 2005, respectively. The increased expenditures in the second quarter and first six months of fiscal 2006 resulted primarily from increased spending associated with building new restaurants. Net cash flows used in financing activities included $30 million in dividends paid in the second quarter and first six months of fiscal 2006, compared to $6 million for the same periods in fiscal 2005. On September 22, 2005, the Board of Directors declared an increase in the cash dividend to twenty cents per share to be paid on November 1, 2005 to all shareholders of record as of the close of business on October 10, 2005. Based on this twenty cent semi-annual dividend declaration, our indicated annual dividend is forty cents per share. Previously, we had paid a semi-annual dividend of four cents per share. Net cash flows provided by operating activities included $72 million and $76 million in income taxes paid in the second quarter and first six months of fiscal 2006, compared to $4 million and $10 million for the same periods in fiscal 2005. The increase in tax payments in fiscal 2006 resulted primarily from accelerated deductions allowable for depreciation of certain capital expenditures during the first six months of fiscal 2005, which lowered our income tax payments in those periods. These accelerated deductions were not available for fiscal 2006 expenditures. The increase in tax payments in the first six months of fiscal 2006 compared to the first six months of fiscal 2005 is also due to the tax payment extension provided by the Internal Revenue Service ("IRS") in the second quarter of fiscal 2005. This extension was provided to all Florida taxpayers in the disaster area counties struck by tropical storm Bonnie and hurricanes Charley and Frances in August and September 2005. Tax payments due in the second quarter of fiscal 2005 were remitted to the IRS in the third quarter of fiscal 2005. A table of our contractual obligations and other commercial commitments as of May 29, 2005 was included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended May 29, 2005. During the quarter ended August 28, 2005, the issuance of our unsecured senior notes in August 2005 increased the amount of payments due in respect of long-term debt. During the quarter ended November 27, 2005, the repayment of unsecured senior notes at maturity in September 2005 decreased the amount of payments due in respect of long-term debt. At November 27, 2005, the amount of payments due in respect of long-term debt in the less than one year period was $195.7 million, in the 1-3 year period was $221.1 million, in the 3-5 year period was $216.7 million, and in the more than 5 year period was $632.4 million. There were no other significant changes to our contractual obligations and other commercial commitments during the six months ended November 27, 2005. We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, sales or expenses, results of operations, liquidity, capital expenditures or capital resources. We are not aware of any trends or events that would materially affect our capital requirements or liquidity. We believe that our internal cash generating capabilities and borrowings available under our shelf registration statement for unsecured debt securities and short-term commercial paper program will be sufficient to finance our capital expenditures, dividends, stock repurchase program and other operating activities through fiscal 2006. 18
FINANCIAL CONDITION Our current assets totaled $463 million at November 27, 2005, compared to $407 million at May 29, 2005. The increase resulted primarily from an increase of $30 million in cash and cash equivalents and $10 million in short-term investments. These increases are primarily due to the portion of the proceeds remaining from the issuance of $300 million of senior notes in August 2005. Inventories of $247 million at November 27, 2005, increased from $235 million at May 29, 2005, principally due to seasonality. Our current liabilities totaled $889 million at November 27, 2005, compared to $1.04 billion at May 29, 2005. Accounts payable of $210 million at November 27, 2005, increased from $191 million at May 29, 2005, principally due to the timing and terms of inventory purchases, capital expenditures and related payments. Accrued payroll of $103 million at November 27, 2005, decreased from $115 million at May 29, 2005, principally due to the payout of the fiscal 2005 incentive compensation during the first quarter of fiscal 2006, which is partially offset by the amounts accrued for fiscal 2006 incentive compensation. Current portion of long-term debt decreased from $300 million to $150 million due to the repayment of $150 million of unsecured 8.375 percent senior notes at maturity in September 2005. Long-term debt of $646 million at November 27, 2005, increased from $350 million at May 29, 2005, primarily from the issuance of $300 million of senior notes in August 2005. CRITICAL ACCOUNTING POLICIES We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of sales and expenses during the reporting period (see Note 1, "Summary of Significant Accounting Policies" under Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of our Annual Report on Form 10-K for the fiscal year ended May 29, 2005). Actual results could differ from those estimates. Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and operating results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements. Land, Buildings and Equipment Land, buildings and equipment are recorded at cost less accumulated depreciation. Building components are depreciated over estimated useful lives ranging from seven to 40 years using the straight-line method. Leasehold improvements, which are reflected on our consolidated balance sheets as a component of buildings, are amortized over the lesser of the expected lease term, including cancelable option periods, or the estimated useful lives of the related assets using the straight-line method. Equipment is depreciated over estimated useful lives ranging from two to 10 years, also using the straight-line method. Accelerated depreciation methods are generally used for income tax purposes. Our accounting policies regarding land, buildings and equipment, including leasehold improvements, include our judgments regarding the estimated useful lives of these assets, the residual values to which the assets are depreciated or amortized, the determination of what constitutes expected lease term and the determination as to what constitutes enhancing the value of or increasing the life of existing assets. These judgments and estimates could produce materially different amounts of reported depreciation and amortization expense if different assumptions were used. As discussed further below, these judgments may also impact our need to recognize an impairment charge on the carrying amount of these assets as the cash flows associated with the assets are realized. Leases We are obligated under various lease agreements for certain restaurants. We recognize rent expense on a straight-line basis over the expected lease term, including cancelable option periods as described below. Within the provisions of certain of our leases, there are rent holidays and/or escalations in payments over the base lease term, as well as renewal periods. The effects of the holidays and escalations have been reflected in rent expense on a 19
straight-line basis over the expected lease term, which includes cancelable option periods when it is deemed to be reasonably assured that we would incur an economic penalty for not exercising the option. The lease term commences on the date when we have the right to control the use of the leased property, which is typically before rent payments are due under the terms of the lease. Many of our leases have renewal periods totaling five to 20 years, exercisable at our option and require payment of property taxes, insurance and maintenance costs in addition to the rent payments. The consolidated financial statements reflect the same lease term for amortizing leasehold improvements as we use to determine capital versus operating lease classifications and in calculating straight-line rent expense for each restaurant. Percentage rent expense is generally based upon sales levels and is accrued at the point in time we determine that it is probable that such sales levels will be achieved. Our judgments related to the probable operating term for each restaurant affect the classification and accounting for leases as capital versus operating, the rent holidays and escalation in payments that are included in the calculation of straight-line rent and the term over which leasehold improvements for each restaurant facility are amortized. These judgments may produce materially different amounts of depreciation, amortization and rent expense than would be reported if different assumed lease terms were used. Impairment of Long-Lived Assets Land, buildings and equipment and certain other assets, including capitalized software costs and liquor licenses, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to the future undiscounted net cash flows expected to be generated by the assets. Identifiable cash flows are measured at the lowest level for which they are largely independent of the cash flows of other groups of assets and liabilities, generally at the restaurant level. If these assets are determined to be impaired, the amount of impairment recognized is the amount by which the carrying amount of the assets exceeds their fair value. Fair value is generally determined by appraisals or sales prices of comparable assets. Restaurant sites and certain other assets to be disposed of are reported at the lower of their carrying amount or fair value, less estimated costs to sell. Restaurant sites and certain other assets to be disposed of are included in assets held for sale when certain criteria are met. These criteria include the requirement that the likelihood of disposing of these assets within one year is probable. Assets whose disposal is not probable within one year remain in land, buildings and equipment until their disposal is probable within one year. The judgments we make related to the expected useful lives of long-lived assets and our ability to realize undiscounted cash flows in excess of the carrying amounts of these assets are affected by factors such as the ongoing maintenance and improvements of the assets, changes in economic conditions and changes in usage or operating performance. As we assess the ongoing expected cash flows and carrying amounts of our long-lived assets, significant adverse changes in these factors could cause us to realize a material impairment charge. During fiscal 2005, we recognized asset impairment charges of $6 million ($4 million after-tax) for the write-down of two Olive Garden restaurants, one Red Lobster restaurant and one Smokey Bones restaurant based on an evaluation of expected cash flows. These restaurants were closed in fiscal 2006. 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 claims that generally exceed $0.25 million for workers' compensation and general liability claims. 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 regarding 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. 20
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. Our estimates are based 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. Income tax returns are subject to audit by federal, 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. FUTURE APPLICATION OF ACCOUNTING STANDARDS In December 2004, the FASB issued SFAS No. 123 (Revised), "Share-Based Payment." SFAS No. 123R revises SFAS No. 123, "Accounting for Stock-Based Compensation" and generally requires the cost associated with employee services received in exchange for an award of equity instruments to be measured based on the grant-date fair value of the award and recognized in the financial statements over the period during which employees are required to provide service in exchange for the award. SFAS No. 123R also provides guidance on how to determine the grant-date fair value for awards of equity instruments as well as alternative methods of adopting its requirements. SFAS No. 123R is effective for annual reporting periods beginning after June 15, 2005. As disclosed in Note 3 to the Consolidated Financial Statements, based on the current assumptions and calculations used, had we recognized compensation expense based on the fair value of awards of equity instruments, net earnings would have been reduced by approximately $3 million and $8 million for quarter and six months ended November 27, 2005, respectively, and $4 million and $8 million for the quarter and six months ended November 28, 2004, respectively. We have not yet determined the method of adoption or the effect of adopting SFAS No. 123R and have not determined whether the adoption will result in future amounts similar to the current pro forma disclosures under SFAS No. 123. FORWARD-LOOKING STATEMENTS Certain statements included in this report and other materials filed or to be filed by us with the SEC (as well as information included in oral or written statements made or to be made by us) may contain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, as codified in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Words or phrases such as "believe," "plan," "will," "expect," "intend," "estimate," and "project," and similar expressions are intended to identify forward-looking statements. All of these statements, and any other statements in this report that are not historical facts, are forward-looking. Examples of forward-looking statements include, but are not limited to, projections regarding: our growth plans and the number and type of expected new restaurant openings and related capital expenditures; same-restaurant sales growth; expected diluted net earnings per share growth; expected trends that might impact capital requirements and liquidity; expected contributions to our defined benefit pension plans; and the impact of litigation on our financial position; and the impact of Hurricanes Katrina and Rita on our fiscal 2006 sales and net earnings. These forward-looking statements are based on assumptions concerning important factors, risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, could cause the actual results to differ materially from those expressed in the forward-looking statements. These factors, risks and uncertainties include, but are not limited to: o intense competition, especially with respect to pricing, service, location, personnel and type and quality of food; o economic and business factors, both specific to the restaurant industry and general economic factors, including changes in consumer preferences, demographic trends, severe weather, a protracted economic slowdown or worsening economy, industry-wide cost pressures, public safety conditions, including actual or threatened armed conflicts or terrorist attacks, and public health conditions, including an actual or potential avian flu pandemic; o the price and availability of food, ingredients and utilities, including the general risk of inflation; o labor and insurance costs, including increased labor costs as a result of federal and state-mandated increases in minimum wage rates and increased insurance costs as a result of increases in our current insurance premiums; o increased advertising and marketing costs; o higher-than-anticipated costs to open, close, relocate or remodel restaurants; 21
o litigation by employees, consumers, suppliers, shareholders or others, regardless of whether the allegations made against us are valid or we are ultimately found liable; o unfavorable publicity relating to food safety or other concerns; o a lack of suitable new restaurant locations or a decline in the quality of the locations of our current restaurants; o government regulations, including federal, state and local laws and regulations relating to our relationships with our employees, zoning, land use, environmental matters and liquor licenses; and o a failure to achieve growth objectives, including lower-than-expected sales and profitability of newly-opened restaurants, our expansion of newer concepts that have not yet proven their long-term viability, our ability to develop new concepts, risks associated with growth through acquisitions and our ability to manage risks relating to the opening of new restaurants, including real estate development and construction activities, union activities, the issuance and renewal of licenses and permits, the availability of funds to finance growth and our ability to hire and train qualified personnel. Item 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to a variety of market risks, including fluctuations in interest rates, foreign currency exchange rates and commodity prices. To manage this exposure, we periodically enter into interest rate, foreign currency exchange and commodity instruments for other than trading purposes. We use the variance/covariance method to measure value at risk, over time horizons ranging from one week to one year, at the 95 percent confidence level. As of November 27, 2005, our potential losses in future net earnings resulting from changes in foreign currency exchange rate instruments, commodity instruments and floating rate debt interest rate exposures were approximately $8 million over a period of one year. The value at risk from an increase in the fair value of all of our long-term fixed rate debt, over a period of one year, was approximately $51 million. The fair value of our long-term fixed rate debt during the first six months of fiscal 2006 averaged $775 million, with a high of $967 million and a low of $651 million. The increase in the fair value of our long-term fixed rate debt is primarily due to the issuance of $300 million of senior notes in August 2005. A portion of the proceeds from this issuance was used to repay at maturity our outstanding $150 million of 8.375 percent senior notes on September 15, 2005. We intend to use the remaining proceeds from the issuance to repay at maturity our outstanding $150 million of 6.375 percent notes due February 1, 2006. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows by targeting an appropriate mix of variable and fixed rate debt. Item 4. Controls and Procedures Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of November 27, 2005, the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of November 27, 2005. During the fiscal quarter ended November 27, 2005, there was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 22
PART II OTHER INFORMATION Item 1. Legal Proceedings We are subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of our business. A number of these lawsuits, proceedings and claims may exist at any given time. These matters typically involve claims from guests, employees and others related to operational issues common to the restaurant industry, and can also involve infringement of, or challenges to, our trademarks. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, we believe that the final disposition of the lawsuits, proceedings and claims in which we are currently involved, either individually or in the aggregate, will not have a material adverse effect on our financial position, results of operations or liquidity. Like other restaurant companies and retail employers, we have been faced in a few states with allegations of purported class-wide wage and hour violations. The following is a brief description of the more significant of these matters. In view of the inherent uncertainties of litigation, the outcome of any unresolved matter described below cannot be predicted at this time, nor can the amount of any potential loss be reasonably estimated. In March 2003 and March 2002, two purported class action lawsuits were brought against us in the Superior Court of Orange County, California by three current and former hourly restaurant employees alleging violations of California labor laws with respect to providing meal and rest breaks. Although we continue to believe we provided the required meal and rest breaks to our employees, to avoid potentially costly and protracted litigation, we agreed during the second quarter of fiscal 2005 to settle both lawsuits and a similar case filed in Sacramento County for approximately $9.5 million. Terms of the settlement, which do not include any admission of liability by us, have received preliminary judicial approval, and claims administration is underway. During the quarter ended November 27, 2005, we paid $3.7 million towards the settlement of these claims. The remaining $5.8 million was paid in December 2005 and is included in other current liabilities at November 27, 2005. In August 2003, three former employees in Washington filed a similar purported class action in Washington State Superior Court in Spokane County alleging violations of Washington labor laws with respect to providing rest breaks. The Court stayed the action and ordered the plaintiffs into our mandatory arbitration program. The plaintiffs' motion for reconsideration was not granted; their appeal of the denial of reconsideration was also not granted, and the plaintiffs subsequently filed a demand for arbitration. We believe we provided the required meal and rest breaks to our employees, and we intend to vigorously defend our position in this case. Beginning in 2002, a total of five purported class action lawsuits were filed in Superior Courts of California (two each in Los Angeles County and Orange County, and one in Sacramento County) in which the plaintiffs allege that they and other current and former service managers, beverage and hospitality managers and culinary managers were improperly classified as exempt employees under California labor laws. The plaintiffs seek unpaid overtime wages and penalties. Two of the cases have been removed to arbitration under our mandatory arbitration program, one has been stayed to allow consideration of judicial coordination with the other cases, one is proceeding as an individual claim, and one remains a purported class action litigation matter. We believe we properly classified these employees as exempt under California law, and we intend to vigorously defend against all claims in these lawsuits. 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The table below provides information concerning our repurchase of shares of our common stock during the quarter ended November 27, 2005. Since commencing repurchases in December 1995, we have repurchased a total of 126.4 million shares under authorizations from our Board of Directors to repurchase an aggregate of 137.4 million shares. <TABLE> <CAPTION> - ---------------------------------- ------------------- -------------- ----------------------- ----------------------- Total Number of Maximum Number of Shares Purchased as Shares that Total Number Average Part of Publicly May Yet be Purchased of Shares Price Paid Announced Plans or Under the Plans or Period Purchased (1) per Share Programs Programs (2) - ---------------------------------- ------------------- -------------- ----------------------- ----------------------- <S> <C> <C> <C> <C> August 29, 2005 through October 2, 2005 1,785,051 $30.88 1,785,051 10,976,004 - ---------------------------------- ------------------- -------------- ----------------------- ----------------------- October 3, 2005 through October 30, 2005 -- -- -- 10,976,004 - ---------------------------------- ------------------- -------------- ----------------------- ----------------------- October 31, 2005 through November 27, 2005 130 $33.28 130 10,975,874 - ---------------------------------- ------------------- -------------- ----------------------- ----------------------- Total 1,785,181 $30.88 1,785,181 10,975,874 - ---------------------------------- ------------------- -------------- ----------------------- ----------------------- </TABLE> (1) All of the shares purchased during the quarter ended November 27, 2005 were purchased as part of our repurchase program, the authority for which was increased to an aggregate of 137.4 million shares by our Board of Directors on September 28, 2004, and announced publicly in a press release issued the same day. There is no expiration date for our program. The number of shares purchased includes shares withheld for taxes on vesting of restricted stock and shares delivered or deemed to be delivered to us on tender of stock in payment for the exercise price of options. These shares are included as part of our repurchase program and deplete the repurchase authority granted by our Board. The number of shares repurchased excludes shares we reacquired pursuant to tax withholding on option exercises or forfeiture of restricted stock. (2) Repurchases are subject to prevailing market prices, may be made in open market or private transactions and may occur or be discontinued at any time. There can be no assurance that we will repurchase any shares. Item 4. Submission of Matters to a Vote of Security Holders (a) Our Annual Meeting of Shareholders was held on September 21, 2005. (b) The name of each director elected at the meeting is provided in Item 4(c) of this report. There are no other directors with a term of office that continued after the Annual Meeting. (c) At the Annual Meeting, the shareholders took the following actions: (i) Elected the following fourteen directors: For Withheld ----------- ------------- Leonard L. Berry 129,416,206 4,272,746 Odie C. Donald 128,403,759 5,285,193 David H. Hughes 128,336,833 5,352,119 Charles A. Ledsinger, Jr. 131,116,719 2,572,233 Joe R. Lee* 122,737,587 10,951,365 William M. Lewis, Jr. 132,342,827 1,346,125 Senator Connie Mack,III 127,979,614 5,709,338 Andrew H. Madsen 129,436,253 4,252,699 Clarence Otis, Jr. 129,417,682 4,271,270 Michael D. Rose 126,043,862 7,645,091 Maria A. Sastre 128,285,308 5,403,644 Jack A. Smith 128,223,447 5,465,505 Blaine Sweatt, III 129,387,049 4,301,903 Rita P. Wilson 129,442,175 4,246,777 24
* Mr. Lee retired as Chairman of the Company's Board of Directors, and was succeeded as Chairman by Clarence Otis, Jr., effective November 29, 2005. (ii) Ratified the appointment of KPMG LLP as our independent registered public accounting firm for the fiscal year ending May 28, 2006. For 123,306,660 Against 9,002,075 Abstain 1,380,217 Item 5. Other Information In accordance with expectations disclosed in our Current Report on Form 8-K filed August 11, 2004, our Quarterly Report on Form 10-Q for the quarter ended August 29, 2004, and our Proxy Statement dated August 9, 2005, Joe R. Lee retired as Chairman of our Board of Directors effective November 29, 2005, and Clarence Otis, Jr., our Chief Executive Office, became Chairman at that time. Mr. Lee is no longer an officer or director of the Company, and Mr. Otis is our Chairman and Chief Executive Officer. Item 6. Exhibits Exhibit 10 Darden Restaurants, Inc. Director Compensation Program, effective as of October 1, 2005 (incorporated by reference to Exhibit 10 to our Current Report on Form 8-K filed December 15, 2005). Exhibit 12 Computation of Ratio of Consolidated Earnings to Fixed Charges. Exhibit 31(a) Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31(b) Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32(a) Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32(b) Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 25
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DARDEN RESTAURANTS, INC. Dated: January 5, 2006 By: /s/Paula J. Shives ------------------------------ Paula J. Shives Senior Vice President, General Counsel and Secretary Dated: January 5, 2006 By: /s/Linda J. Dimopoulos ------------------------------ Linda J. Dimopoulos Senior Vice President and Chief Financial Officer (Principal financial officer) 26
INDEX TO EXHIBITS Exhibit Number Exhibit Title 10 Darden Restaurants, Inc. Director Compensation Program, effective as of October 1, 2005 (incorporated by reference to Exhibit 10 to our Current Report on Form 8-K filed December 15, 2005). 12 Computation of Ratio of Consolidated Earnings to Fixed Charges. 31(a) Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31(b) Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32(a) Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32(b) Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 27