Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk from changes in commodity prices, labor inflation, interest rates and foreign currency exchange rates.
Commodity Pricing Risk
Many of the ingredients used in the products sold in our restaurants are commodities that are subject to unpredictable price volatility. Although we attempt to minimize the effect of price volatility by negotiating fixed price contracts for the supply of key ingredients, there are no established fixed price markets for certain commodities such as produce and wild fish, and we are subject to prevailing market conditions when purchasing those types of commodities. Other commodities are purchased based upon negotiated price ranges established with vendors with reference to the fluctuating market prices. The related agreements may contain contractual features that limit the price paid by establishing certain price floors and caps. As of December 31, 2023, approximately 70% of our estimated 2024 annual food purchases are covered by fixed contracts, most of which are scheduled to expire during 2024.
During 2023, we experienced 4.3% commodity inflation in the U.S. and anticipate 3% to 4% commodity inflation for 2024. Extreme changes in commodity prices or long-term changes could affect our financial results adversely. Currently we do not use financial instruments to hedge our commodity risk.
In addition to the market risks identified above, we are subject to business risk as our U.S. beef and Brazil pork supplies are highly dependent upon a limited number of vendors. If these vendors were unable to fulfill their obligations under their contracts, we could encounter supply shortages and incur higher costs to secure adequate supplies. See Note 21 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for further details.
Labor Inflation
Our restaurant operations are subject to federal and state minimum wage and other laws governing such matters as working conditions, overtime and tip credits. A significant number of our restaurant team members are paid at rates related to the federal and/or state minimum wage and, accordingly, increases in the minimum wage increase our labor costs. During 2023, we experienced 5.3% labor cost inflation in the U.S.
Interest Rate Risk
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. We manage our exposure to market risk through regular operating and financing activities, using a combination of fixed-rate and variable-rate debt, and when deemed appropriate, through the use of derivative financial instruments. The amount of variable-rate debt fluctuates during the year based on our working capital requirements. As of December 31, 2023, our interest rate risk was primarily from variable interest rate changes on our revolving credit facility, which had an outstanding balance of $381.0 million.
We periodically evaluate financial instruments to hedge our exposure to variable interest rates. We use derivative financial instruments as risk management tools and not for speculative purposes. To manage the risk of fluctuations in variable interest rate debt, we have interest rate swaps with an aggregate notional amount of $200.0 million, with $100.0 million maturing on December 31, 2024 and $100.0 million maturing on December 31, 2025. See Note 16 - Derivative Instruments and Hedging Activities of the Notes to Consolidated Financial Statements for further information.
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We utilize valuation models to estimate the effects of changing interest rates. The following table summarizes the changes to fair value and interest expense under a shock scenario. This analysis assumes that interest rates change suddenly, as an interest rate “shock”, and continue to increase or decrease at a consistent level above or below the SOFR curve.
DECEMBER 31, 2023
(dollars in thousands) INCREASE DECREASE
Change in fair value (1):
Interest rate swap $ 5,230 $ (5,427)
Change in annual interest expense (1):
Variable rate debt $ 3,620 $ (3,620)
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(1) The potential change from a hypothetical 200 basis point increase (decrease) in short-term interest rates.
Foreign Currency Exchange Rate Risk
We are subject to foreign currency exchange risk for our restaurants operating in foreign countries. Our exposure to foreign currency exchange risk is primarily related to fluctuations in the Brazilian Real relative to the U.S. dollar. Our operations in other markets consist of Company-owned restaurants on a smaller scale than Brazil. If foreign currency exchange rates depreciate in the countries in which we operate, we may experience declines in our operating results. Currently, we do not use financial instruments to hedge foreign currency exchange rate changes.
For 2023, 13.2% of our revenue was generated in foreign currencies. A 10% change in average foreign currency rates against the U.S. dollar would have increased or decreased our Total revenues and Net income for our foreign entities by $67.0 million and $8.5 million, respectively.
This market risk discussion contains forward-looking statements. Actual results may differ materially from the discussion based upon general market conditions and changes in U.S. and global financial markets.
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