Derivative Instruments and Hedging Activities

We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments as required by 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 ASC Topic 815, 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 ASC Topic 815, 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 24, 2014, 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, currency 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 our derivative contracts are as follows:



	Notional Values
(in millions)	August 24, 2014		May 25, 2014
Derivative contracts designated as hedging instruments
Commodities	$	—	$	0.9
Foreign currency	—		0.3
Interest rate swaps	200.0		200.0
Equity forwards	18.0		20.6
Derivative contracts not designated as hedging instruments
Equity forwards	$	45.1	$	47.4

We are currently party to interest-rate swap agreements with $200.0 million of notional value to limit the risk of changes in fair value of a portion of the $121.9 million 4.500 percent senior notes due October 2021 and a portion of the $500.0 million 6.200 percent senior notes due October 2017. 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 24, 2014 and August 25, 2013, $0.5 million and $0.5 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 24, 2014, we were party to equity forward contracts that were indexed to 0.8 million shares of our common stock, at varying forward rates between $31.19 per share and $52.66 per share, extending through August 2018. 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 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 $46.17 and $51.95 per share, can only be net settled in cash and expire between fiscal 2016 and 2019. 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 are as follows:



	Balance Sheet Location	Derivative Assets				Derivative Liabilities
(in millions)	Balance Sheet Location	August 24, 2014		May 25, 2014		August 24, 2014		May 25, 2014
Derivative contracts designated as hedging instruments
Equity forwards	(1)	0.5		—		—		(0.5		)
Interest rate related	(1)	2.3		1.6		—		—
Foreign currency forwards	(1)	—		0.1		—		—
		$	2.8	$	1.7	$	—	$	(0.5	)
Derivative contracts not designated as hedging instruments
Equity forwards	(1)	0.8		—		—		(1.2		)
		$	0.8	$	—	$	—	$	(1.2	)
Total derivative contracts		$	3.6	$	1.7	$	—	$	(1.7	)


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

The effects of derivative instruments in cash flow hedging relationships in 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 24, 2014			August 25, 2013				August 24, 2014			August 25, 2013				August 24, 2014		August 25, 2013
Commodity	$	—		$	(0.4	)	(2)	$	—		$	(0.2	)	(2)	$	—	$	—
Equity	(2.0		)	(4.3		)	(3)	(0.9		)	(0.7		)	(3)	0.3		0.3
Interest rate	—			—			Interest, net	(40.5		)	(2.6		)	Interest, net	—		—
Foreign currency	—			0.2			(4)	—			0.1			(4)	—		—
	$	(2.0	)	$	(4.5	)		$	(41.4	)	$	(3.4	)		$	0.3	$	0.3


(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 may 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 in 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

Hedged Item

Three Months Ended

August 24,
2014

August 25,
2013

August 24,
2014

August 25,
2013

Interest rate

0.7

(4.9

)

Interest, net

Fixed-rate debt

(0.7

)

4.9

Interest, net

The effects of derivatives not designated as hedging instruments in 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 24, 2014			August 25, 2013
(in millions)		August 24, 2014			August 25, 2013
Commodity contracts	Cost of Sales (1)	$	—		$	(0.5	)
Equity forwards	Cost of Sales (2)	(0.6		)	(1.5		)
Equity forwards	Selling, General and Administrative	(1.8		)	(4.0		)
		$	(2.4	)	$	(6.0	)


(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 24, 2014, we expect to reclassify $5.2 million of net losses on derivative instruments from accumulated other comprehensive income (loss) to earnings during the next twelve months based on the maturity of our equity forward contracts and amortization of deferred losses on settled 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.