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Derivative Instruments And Hedging Activities
 3 Months Ended
Aug. 28, 2011
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments And Hedging Activities
Derivative Instruments and Hedging Activities
We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments as required by Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 815, Derivatives and Hedging, and those utilized as economic hedges. We use financial and commodities derivatives to manage interest rate, compensation and commodities pricing and foreign currency exchange rate risks inherent in our business operations. To the extent our derivatives are effective in offsetting the variability of the hedged cash flows, and otherwise meet the cash flow hedge accounting criteria required by Topic 815 of the FASB ASC, changes in the derivatives’ fair value are not included in current earnings but are included in accumulated other comprehensive income (loss), net of tax. These changes in fair value will be reclassified into earnings at the time of the forecasted transaction. Ineffectiveness measured in the hedging relationship is recorded currently in earnings in the period in which it occurs. To the extent our derivatives are effective in mitigating changes in fair value, and otherwise meet the fair value hedge accounting criteria required by Topic 815 of the FASB ASC, gains and losses in the derivatives’ fair value are included in current earnings, as are the gains and losses of the related hedged item. To the extent the hedge accounting criteria are not met, the derivative contracts are utilized as economic hedges and changes in the fair value of such contracts are recorded currently in earnings in the period in which they occur.
By using these instruments, we expose ourselves, from time to time, to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. We minimize this credit risk by entering into transactions with high quality counterparties. We currently do not have any provisions in our agreements with counterparties that would require either party to hold or post collateral in the event that the market value of the related derivative instrument exceeds a certain limit. As such, the maximum amount of loss due to counterparty credit risk we would incur at August 28, 2011, if counterparties to the derivative instruments failed completely to perform, would approximate the values of derivative instruments currently recognized as assets in our consolidated balance sheet. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates, commodity prices, or the market price of our common stock. We minimize this market risk by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
 
The notional values of derivative contracts designated as hedging instruments and derivative contracts that are not designated as hedging instruments are as follows: 
 
 
Notional Values
(in millions)
 
August 28,

2011
 
May 29,

2011
Derivative contracts designated as hedging instruments
 
 
 
 
Natural gas
 
$
1.0


 
$
3.8


Other commodities
 
12.5


 
—


Foreign currency
 
15.6


 
20.7


Interest rate locks
 
300.0


 
150.0


Interest rate swaps
 
450.0


 
350.0


Equity forwards
 
16.3


 
18.0


Derivative contracts not designated as hedging instruments
 
 
 
 
Natural gas
 
$
7.7


 
$
7.7


Other commodities
 
14.3


 
12.7


Equity forwards
 
21.4


 
24.0




We periodically enter into natural gas futures, swaps and option contracts (collectively, natural gas contracts) to reduce the risk of variability in cash flows associated with fluctuations in the price of natural gas during the fiscal year. For a certain portion of our natural gas purchases, changes in the price we pay for natural gas is highly correlated with changes in the market price of natural gas. For these natural gas purchases, we designate natural gas contracts as cash flow hedging instruments. For the remaining portion of our natural gas purchases, changes in the price we pay for natural gas are not highly correlated with changes in the market price of natural gas, generally due to the timing of when changes in the market prices are reflected in the price we pay. For these natural gas purchases, we utilize natural gas contracts as economic hedges. Our natural gas contracts currently extend through September 2012.
We periodically enter into other commodity futures and swaps (typically for soybean oil, milk, diesel fuel and butter) to reduce the risk of fluctuations in the price we pay for these commodities, which are either used directly in our restaurants (i.e., class III milk contracts for cheese and soybean oil for salad dressing) or are components of the cost we pay for items used in our restaurants (i.e., diesel fuel contracts to mitigate risk related to diesel fuel surcharges charged by our distributors). Our other commodity futures and swap contracts currently extend through October 2012.
We periodically enter into foreign currency forward contracts to reduce the risk of fluctuations in exchange rates specifically related to forecasted transactions or payments made in a foreign currency either for commodities and items used directly in our restaurants or for forecasted payments of services. Our foreign currency forward contracts currently extend through June 2012.
We entered into treasury-lock derivative instruments with $300.0 million of notional value to hedge a portion of the risk of changes in the benchmark interest rate associated with the expected issuance of long-term debt in the second quarter of fiscal 2012, as changes in the benchmark interest rate will cause variability in our forecasted interest payments. These derivative instruments are designated as cash flow hedges.
We entered into forward-starting interest rate swap agreements with $300.0 million of notional value to hedge a portion of the risk of changes in the benchmark interest rate associated with the expected issuance of long-term debt to refinance our $350.0 million 5.625 percent senior notes due October 2012, as changes in the benchmark interest rate will cause variability in our forecasted interest payments. These derivative instruments are designated as cash flow hedges.
We entered into interest rate swap agreements with $150.0 million of notional value to limit the risk of changes in fair value of a portion of the $350.0 million 5.625 percent senior notes due October 2012 attributable to changes in the benchmark interest rate, between inception of the interest rate swap agreements and maturity of the related debt. The swap agreements effectively swap the fixed rate obligations for floating rate obligations, thereby mitigating changes in fair value of the related debt prior to maturity. The swap agreements were designated as fair value hedges of the related debt and met the requirements to be accounted for under the short-cut method, resulting in no ineffectiveness in the hedging relationship. During the quarters ended August 28, 2011 and August 29, 2010, $0.7 million and $1.0 million, respectively, was recorded as a reduction to interest expense related to the net swap settlements.
We enter into equity forward contracts to hedge the risk of changes in future cash flows associated with the unvested, unrecognized Darden stock units. 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 contracts were initially designated as cash flow hedges to the extent the Darden stock units are unvested and, therefore, unrecognized as a liability in our financial statements. As of August 28, 2011, we were party to equity forward contracts that were indexed to 0.8 million shares of our common stock, at varying forward rates between $27.57 per share and $42.08 per share, extending through August 2015. The forward contracts can only be net settled in cash. As the Darden stock units vest, we will 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. We periodically incur interest on the notional value of the contracts and receive dividends on the underlying shares. These amounts are recognized currently in earnings as they are incurred.
We entered into equity forward contracts to hedge the risk of changes in future cash flows associated with recognized, cash-settled performance stock units and employee-directed investments in Darden stock within the non-qualified deferred compensation plan. The equity forward contracts are indexed to 0.2 million shares of our common stock at forward rates between $23.41 and $50.19 per share, can only be net settled in cash and expire between fiscal 2012 and 2016. We did not elect hedge accounting with the expectation that changes in the fair value of the equity forward contracts would offset changes in the fair value of the performance stock units and Darden stock investments in the non-qualified deferred compensation plan within selling, general and administrative expenses in our consolidated statements of earnings.
The fair value of our derivative contracts designated as hedging instruments and derivative contracts that are not designated as hedging instruments are as follows: 
  
 
Balance
Sheet
Location
 
Derivative Assets
 
Derivative Liabilities
(in millions)
 
August 28,

2011
 
May 29,

2011
 
August 28,

2011
 
May 29,

2011
Derivative contracts designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
Commodity contracts
 
(1)
 
$
—


 
$
0.1


 
$
(0.4
)
 
$
—


Equity forwards
 
(1)
 
—


 
0.4


 
(1.6
)
 
—


Interest rate related
 
(1)
 
2.9


 
3.6


 
(65.1
)
 
(23.2
)
Foreign currency forwards
 
(1)
 
0.2


 
0.6


 
—


 
—


 
 
 
 
$
3.1


 
$
4.7


 
$
(67.1
)
 
$
(23.2
)
Derivative contracts not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
Commodity contracts
 
(1)
 
$
0.1


 
$
0.6


 
$
(1.4
)
 
$
—


Equity forwards
 
(1)
 
—


 
0.5


 
(1.8
)
 
—


 
 
 
 
$
0.1


 
$
1.1


 
$
(3.2
)
 
$
—


Total derivative contracts
 
$
3.2


 
$
5.8


 
$
(70.3
)
 
$
(23.2
)
 
(1)
Derivative assets and liabilities are included in receivables, net, prepaid expenses and other current assets, other current liabilities, and other liabilities, as applicable, on our consolidated balance sheets.


The effects of derivative instruments in cash flow hedging relationships on the consolidated statements of earnings are as follows:
 
(in millions)
 
Amount of Gain (Loss)
Recognized in AOCI
(effective portion)
 
Location of
Gain (Loss)
Reclassified
from AOCI to
Earnings
 
Amount of Gain (Loss)
Reclassified from AOCI to
Earnings (effective portion)
 
Location of
Gain (Loss)
Recognized in
Earnings
(ineffective
portion)
 
(1) Amount of Gain (Loss)
Recognized in Earnings
(ineffective portion)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
Type of Derivative
 
August 28,

2011
 
August 29,

2010
 
 
 
August 28,

2011
 
August 29,

2010
 
 
 
August 28,

2011
 
August 29,

2010
Commodity
 
$
(0.4
)
 
$
(0.2
)
 
(2)
 
$
—


 
$
(0.4
)
 
(2)
 
$
—


 
$
—


Equity
 
(3.5
)
 
(0.4
)
 
(3)
 
—


 
—


 
(3)
 
0.1


 
0.1


Interest rate
 
(41.8
)
 
(20.2
)
 
Interest, net
 
0.2


 
0.1


 
Interest, net
 
(0.2
)
 
—


Foreign currency
 
—


 
0.1


 
(4)
 
0.3


 
0.1


 
(4)
 
—


 
—


 
 
$
(45.7
)
 
$
(20.7
)
 
 
 
$
0.5


 
$
(0.2
)
 
 
 
$
(0.1
)
 
$
0.1


 
 
(1)
Generally, all of our derivative instruments designated as cash flow hedges have some level of ineffectiveness, which is recognized currently in earnings. However, as these amounts are generally nominal and our consolidated financial statements are presented “in millions,” these amounts will generally appear as zero in this tabular presentation.
(2)
Location of the gain (loss) reclassified from AOCI to earnings as well as the gain (loss) recognized in earnings for the ineffective portion of the hedge is food and beverage costs and restaurant expenses, which are components of cost of sales.
(3)
Location of the gain (loss) reclassified from AOCI to earnings as well as the gain (loss) recognized in earnings for the ineffective portion of the hedge is restaurant labor expenses, which is a component of cost of sales, and selling, general and administrative expenses.
(4)
Location of the gain (loss) reclassified from AOCI to earnings as well as the gain (loss) recognized in earnings for the ineffective portion of the hedge is food and beverage costs, which is a component of cost of sales, and selling, general and administrative expenses.
 
The effects of derivative instruments in fair value hedging relationships on the consolidated statements of earnings are as follows:
(in millions)
 
Amount of Gain (Loss)
Recognized in Earnings on
Derivatives
 
Location of
Gain (Loss)
Recognized in
Earnings on
Derivatives
 
Hedged Item in
Fair Value Hedge
Relationship
 
Amount of Gain (Loss)
Recognized in Earnings on
Related Hedged Item
 
Location of
Gain (Loss)
Recognized in
Earnings on
Related
Hedged Item
 
 
Three Months Ended
 
 
 
 
 
Three Months Ended
 
 
 
 
August 28,

2011
 
August 29,

2010
 
 
 
 
 
August 28,

2011
 
August 29,

2010
 
 
Interest rate
 
$
(0.7
)
 
$
1.5


 
Interest, net
 
Fixed-rate debt
 
$
0.7


 
$
(1.5
)
 
Interest, net


 
The effects of derivatives not designated as hedging instruments on the consolidated statements of earnings are as follows:
  
 
Location of Gain (Loss)
Recognized
in Earnings on
Derivatives
 
Amount of Gain (Loss) Recognized in Earnings
 
 
Three Months Ended
 
 
August 28, 2011
 
August 29, 2010
(in millions)
 
 
Commodity contracts
 
(1)
 
$
(1.9
)
 
$
(0.1
)
Equity forwards
 
(2)
 
(0.8
)
 
(0.1
)
Equity forwards
 
Selling, General and Administrative
 
(1.3
)
 
—


 
 
 
 
$
(4.0
)
 
$
(0.2
)
 
(1)
Location of the gain (loss) recognized in earnings is food and beverage costs and restaurant expenses, which are components of cost of sales.
(2)
Location of the gain (loss) recognized in earnings is restaurant labor expenses, which is a component of cost of sales.
Based on the fair value of our derivative instruments designated as cash flow hedges as of August 28, 2011, we expect to reclassify $2.5 million of net losses on derivative instruments from accumulated other comprehensive income (loss) to earnings during the next twelve months based on the timing of our forecasted commodity purchases and maturity of equity forward and interest rate related instruments. However, the amounts ultimately realized in earnings will be dependent on the fair value of the contracts on the settlement dates.