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 29, 2024, approximately 80% of our estimated 2025 annual food purchases are covered by fixed contracts, most of which are scheduled to expire during 2025.
During 2024, we experienced 1.1% commodity inflation in the U.S. and anticipate 2.5% to 3.5% commodity inflation for 2025. 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 supply is 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 18 - 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 2024, we experienced 3.7% labor cost inflation in the U.S and anticipate 4.0% to 5.0% labor cost inflation for 2025.
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 29, 2024, our interest rate risk was primarily from variable interest rate changes on our revolving credit facility.
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 $375.0 million, with $100.0 million maturing on December 31, 2024, $100.0 million maturing on December 31, 2025, and $175.0 million maturing March 31, 2026. See Note 13 - 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 29, 2024
(dollars in thousands) INCREASE DECREASE
Change in fair value (1):
Interest rate swap $ 5,693 $ (5,847)
Change in annual interest expense (1):
Variable rate debt $ 8,700 $ (8,700)
________________
(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. To manage a portion of our exchange rate risk, we entered into foreign currency forward contracts during 2024 to partially offset the foreign currency exchange gains and losses generated by the rate risk associated with the purchase price installment payments from the Brazil Sale Transaction. We recorded gains of $15.7 million as a result of changes in the fair value of foreign currency forward contracts during fiscal year 2024. As of December 29, 2024, the fair value of the derivative instruments was $0.3 million in an asset position.
As of December 29, 2024, our total notional amount of outstanding foreign currency forward contracts was $184.6 million. Subsequent to December 29, 2024, the outstanding notional amount decreased to $107.7 million following the collection of the first installment payment from the Brazil Sale Transaction. A hypothetical 10% increase or decrease in the Brazilian Real relative to the U.S. dollar for the remaining $107.7 million notional amount would result in a corresponding increase or decrease of approximately $8.4 million or $(10.2) million, respectively, in operating income with a corresponding decrease or increase in the U.S. dollar value of the hedged portion of the related receivable.
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 financ ial markets.
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