
1.	Summary of Significant Accounting Policies

Organization and Nature of Operations

P.F. Chang’s China Bistro, Inc. (the “Company” or "PFCB") operates two restaurant concepts consisting of restaurants throughout the United States under the names P.F. Chang’s China Bistro (“Bistro”) and Pei Wei Asian Diner (“Pei Wei”). The Company was formed in 1996 and became publicly traded in 1998. Additionally, the Company has extended its brands to international markets, retail products and domestic airports, with those businesses operating under licensing agreements.

Fiscal Year

The Company’s fiscal year ends on the Sunday closest to the end of December. Fiscal years 2011 and 2010 were each comprised of 52 weeks and fiscal year 2009 was comprised of 53 weeks.

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Principles of Consolidation and Presentation

The Company’s consolidated financial statements include the accounts and operations of the Company and its majority-owned subsidiaries. All material balances and transactions between the consolidated entities have been eliminated. Noncontrolling interests are reported below net income under the heading “Net income attributable to noncontrolling interests” in the consolidated statements of income and shown as a component of equity in the consolidated balance sheets. During fiscal 2011, total revenues reported in the consolidated statements of income has been expanded to display restaurant sales, restaurant licensing revenues and retail licensing revenues.

Cash and Cash Equivalents

The Company’s cash and cash equivalent balances are not pledged or restricted. The Company’s policy is to invest cash in excess of operating requirements in income-producing investments. Income-producing investments with maturities of three months or less at the time of investment are reflected as cash equivalents. Amounts receivable from credit card processors are also considered cash equivalents because they are both short-term and highly liquid in nature and are typically converted to cash within three days of the sales transaction. Cash equivalents as of January 1, 2012 and January 2, 2011 consisted primarily of money market fund investments and amounts receivable from credit card processors.

Inventories

Inventories consist of food, beverages and alcohol and are stated at the lower of cost or market using the first-in, first-out method.

Other Current Assets

Other current assets consist primarily of receivables, current portion of deferred tax asset, income taxes receivable and prepaid rent. Receivables consist primarily of amounts due from third-party gift card sales, rebates and amounts due from landlords for tenant incentives. Management believes outstanding receivable amounts to be collectible.

Property and Equipment

Property and equipment is stated at cost, which includes capitalized interest during the construction and development period, and is depreciated on a straight-line basis over the shorter of useful life or the estimated service life. The Company's home office building is depreciated over thirty years, and building improvements are depreciated over twenty years. Leasehold improvements and buildings under capital leases are depreciated over the shorter of the useful life or the length of the related lease term. The term of the lease includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured and failure to exercise such option would result in an economic penalty. The estimated service life of furniture, fixtures and equipment is seven years. China and smallwares are depreciated over two years up to 50 percent of their original cost, and replacements are recorded as operating expenses as they are purchased.

Depreciation and Amortization

Depreciation and amortization expense included in continuing operations includes the depreciation and amortization of fixed assets, gains and losses on disposal of assets and the amortization of intangible assets, capitalized software costs and non-transferable liquor license fees and totaled $80.4 million, $77.5 million and $74.4 million for the years ended January 1, 2012, January 2, 2011, and January 3, 2010, respectively.

During the years ended January 1, 2012, January 2, 2011, and January 3, 2010, the Company incurred gross interest expense of $0.8 million, $1.7 million, and $3.1 million, respectively. Of these amounts, $0.1 million, $0.1 million, and $0.3 million, respectively, were capitalized during the years ended January 1, 2012, January 2, 2011, and January 3, 2010.

Goodwill and Intangible Assets

Goodwill is not amortized but is subject to annual impairment tests. Intangible assets deemed to have definite lives are amortized over their estimated useful lives, which is generally fifteen years for Bistro restaurants and ten years for Pei Wei restaurants.

Goodwill

Goodwill represents the residual purchase price after allocation of the purchase price of assets acquired and relates to the Company’s purchase of interests in various restaurants at the formation of the Company. Impairment tests are performed with respect to goodwill at the segment level of reporting. On an annual basis, the Company reviews the recoverability of goodwill based primarily on a multiple of earnings analysis which compares the estimated fair value of the reporting segment to the carrying value. As a secondary review, the Company also compares the market value of its common stock to the total Company carrying value. Generally, the Company performs its annual assessment for impairment during the fourth quarter of its fiscal year and performs the analysis more frequently if there are any impairment indicators identified during the year. As of January 1, 2012, management determined there was no impairment of goodwill. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.

Intangible Assets

Intangible assets were historically recognized upon the Company’s buyout of noncontrolling interests when the Company’s purchase price exceeded the imputed fair value at the time of the partners’ original investment. Upon the adoption of noncontrolling interest guidance at the beginning of fiscal 2009, an intangible asset is no longer recognized upon buyout of noncontrolling interests. Instead, any excess of the Company’s purchase price over the imputed fair value is recognized as a reduction of additional paid-in capital in equity.

Impairment of Long-Lived Assets

The Company reviews property and equipment and intangible assets with finite lives (those assets resulting from the acquisition of partners' noncontrolling interests in the operating rights of certain of our restaurants) for impairment when events or circumstances indicate these assets might be impaired, but at least quarterly. An analysis is performed at the individual restaurant level and primarily includes an assessment of historical cash flows and other relevant facts and circumstances. Generally, for restaurants open greater than two years, negative restaurant-level cash flows over the previous twelve-month period is considered a potential impairment indicator. In these situations, the Company evaluates future restaurant cash flow projections in conjunction with qualitative factors and future operating plans. Based on this assessment, the Company either (a) continues to monitor these restaurants over the near-term for evidence of improved performance or (b) immediately recognizes an impairment charge based on the amount by which the asset carrying value exceeds fair value, which is based on discounted estimated future cash flows.

The Company’s impairment assessment process requires the use of estimates and assumptions regarding future cash flows and operating outcomes, which are subject to a significant degree of judgment based on experience and knowledge. These estimates can be significantly impacted by changes in the economic environment, real estate market conditions and overall operating performance. At any given time, the Company is actively monitoring a small number of restaurants and impairment charges could be triggered in the future if individual restaurant performance does not improve or if management decides to close that location. Also, if current economic conditions worsen, additional restaurants could be placed on active monitoring and potentially trigger impairment charges in future periods.

In the past, the majority of the restaurants under monitoring have typically achieved cash flow improvements in a timely fashion such that no impairment charge was deemed necessary and the restaurant was removed from active monitoring. During the year-ended January 1, 2012, the Company recognized asset impairment charges of $10.5 million in the consolidated statements of income, related to the full write-off of the carrying value of the long-lived assets of three Bistro restaurants, which continue to operate, and three Pei Wei restaurants, which closed during the fourth quarter of fiscal 2011. See Note 2 for further discussion. There were no impairments recognized by the Company during the years ended January 2, 2011 and January 3, 2010. There can be no assurance that future impairment tests will not result in additional charges to earnings.

Other Assets

Other assets consist primarily of transferable and nontransferable liquor licenses, Restoration Plan assets (see Note 15 for additional information), receivable under loan facility to True Food Kitchen (see Note 18 for additional information), capitalized software costs, vendor deposits and trademarks. Nontransferable liquor licenses are amortized over the life of the restaurant (twenty years for Bistro and fifteen years for Pei Wei) and trademarks are amortized over the shorter of the useful life of the asset or the length of the related contract term. The term of the lease or contract includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured and failure to exercise such option would result in an economic penalty. Capitalized software costs are typically amortized over five years. See Note 7 for additional details on the Company’s other assets.

Accrued Expenses

Accrued expenses consist primarily of accrued payroll, accrued insurance, sales and use tax payable, accrued rent, performance units and cash-settled awards that will vest within one year and property tax payable. See Note 8 for further details of the Company’s accrued expenses.

The Company is self-insured for certain exposures, principally workers’ compensation, general liability, medical and dental, for the first $100,000, $250,000, $275,000 or $500,000 of individual claims depending on the type of claim. The Company has paid amounts to its insurance carrier or claims administrator that approximate the cost of claims known to date and has accrued additional liabilities for its estimate of ultimate costs related to those claims, including known claims and an actuarially determined estimate of incurred but not yet reported claims. In developing these estimates, the Company uses historical experience factors to estimate the ultimate claim exposure. The Company’s self insurance liabilities are actuarially determined and consider estimates of expected losses, based on statistical analyses of the Company’s actual historical trends as well as historical industry data. It is reasonably possible that future adjustments to these estimates will be required.

Unearned Revenue

The Company sells gift cards to customers in its restaurants, through its websites and via other retail outlets. Unearned revenue represents gift cards sold for which revenue recognition criteria, generally redemption, has not been met. These amounts are presented net of any discounts issued by the Company in connection with the terms of its third-party gift card distribution agreements.

Deferred Rent

The Company leases all of its restaurant properties. At the inception of the lease, each property is evaluated to determine whether the lease will be accounted for as an operating or capital lease. The lease term includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured and failure to exercise such option would result in an economic penalty.

Tenant incentives received from landlords in connection with certain of the Company's operating leases are recorded as a liability within deferred rent and are amortized over the relevant lease term. For leases that contain scheduled rent escalations, the Company recognizes rent expense on a straight-line basis over the term of the lease. The straight-line rent calculation includes the rent holiday period, which begins on the possession date and ends on the store open date.

Many of the Company's leases contain provisions that require additional rental payments based upon restaurant sales volume (“contingent rent”). Contingent rent is recognized as rent expense in the period incurred.

Other Liabilities

Other liabilities include liabilities related to the Restoration Plan (discussed further in Note 15), the Company’s net long-term deferred tax liabilities, performance units and cash-settled awards that will vest in more than one year and asset retirement obligations ("ARO"). See Note 13 for further details of the Company’s other liabilities.

The Company’s AROs are primarily associated with certain of the Company’s restaurant leases under which the landlord has the option to require the Company to remove its leasehold improvements at the end of the lease term and return the property to the landlord in its original condition. The Company estimates the fair value of these liabilities based on estimated store closing costs, accretes that current cost forward to the date of estimated ARO removal and discounts the future cost back as if it were performed at the inception of the lease. At the inception of such a lease, the Company records the ARO liability and also records a related capital asset in an amount equal to the estimated fair value of the liability. The ARO liability is accreted to its future value, with accretion expense recognized as interest and other income, net, and the capitalized asset is depreciated on a straight-line basis over the useful life of the asset, which is generally the life of the leasehold improvement. The estimate of the conditional asset retirement liability is based on a number of assumptions requiring management’s judgment, including the cost to return the space to its original condition, inflation rates and discount rates. As a result, in future periods the Company may make adjustments to the ARO liability as a result of the availability of new information, changes in estimated costs, inflation rates and other factors.

Revenue Recognition

Revenues consist of restaurant sales, restaurant licensing revenues and retail licensing revenues. Restaurant sales represent food, beverage and alcohol sales at the Company's owned restaurants.

The Company recognizes income from gift cards when: (i) the gift card is redeemed by the customer; or (ii) the likelihood of the gift card being redeemed by the customer is remote (gift card breakage) and the Company determines there is no legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions. The Company determines the gift card breakage rate based upon historical redemption patterns. Gift card breakage income was not significant in any fiscal year and is reported within revenues in the consolidated statements of income.

Restaurant licensing revenues include initial territory fees, store opening fees and ongoing royalty fees from all licensed restaurants and two restaurants operated under a joint venture arrangement. Initial territory fees received pursuant to international development and licensing agreements are recognized as revenue when the Company has performed its material obligations under the agreement, which is typically after the opening of a certain number of restaurants within the territory. Store opening fees are recognized as revenue when the Company has substantially performed its obligations to assist the licensee in opening a new restaurant, which is generally at the time such restaurant opens for business. Ongoing royalty fees from licensed restaurants are based on a percentage of restaurant sales and are recognized as revenue in the period the related restaurants’ revenues are earned.

Retail licensing revenues include ongoing royalty fees based on a percentage of licensed retail product sales. Ongoing royalty fees from licensed retail products are based on a percentage of product sales and are recognized as revenue upon the sale of the product to retail outlets.

Advertising

The Company expenses advertising production costs at the time the advertising first takes place. All other advertising costs are expensed as incurred. Advertising expense for the years ended January 1, 2012, January 2, 2011, and January 3, 2010 was $11.9 million, $12.5 million, and $10.4 million, respectively.

Preopening Expense

Preopening expense, consisting primarily of manager salaries, employee payroll and related training costs incurred prior to the opening of a restaurant, is expensed as incurred. Preopening expense also includes the accrual for straight-line rent recorded during the period between date of possession and the restaurant opening date for the Company’s leased restaurant locations.

Partner Investment Expense

Partner investment expense consists primarily of a reversal of previously recognized expense for the difference between the fair value of the noncontrolling interest at inception date and the fair value at the date of repurchase, to the extent that the former is greater, for those interests that are bought out prior to the restaurant reaching maturity (typically after five years of operation). Partner investment expense also includes the difference between the imputed fair value of noncontrolling interests at the time the partners invest in their restaurants and the partners’ cash capital contribution for these ownership interests. Partner investment expense has not been recognized for new Bistro openings since the beginning of fiscal 2007 and for new Pei Wei openings since April 2010 due to changes in the partnership structure.

Consolidated partner investment expense for the years ended January 1, 2012, January 2, 2011, and January 3, 2010 was a net benefit of $0.2 million, $0.3 million and $0.6 million, respectively. See Note 16 for further discussion on the Company’s partnership structure.

Taxes

The Company utilizes the liability method of accounting for income taxes in which deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which the differences are expected to be recovered or settled. The Company recognizes deferred tax assets when future realization is considered by management to be more likely than not.

The Company records a liability for unrecognized tax benefits resulting from tax positions taken, or expected to be taken, in an income tax return. The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. See Note 17 for further discussion of the Company's uncertain tax positions.

Net income attributable to noncontrolling interests relating to the income or loss of consolidated partnerships includes no provision for income taxes as any tax liability related thereto is the responsibility of the individual noncontrolling interest partners.

Sales taxes collected from guests are excluded from revenues. The obligation is included in accrued expenses until the taxes are remitted to the appropriate taxing authorities.

Share-Based Compensation

The Company has granted equity-classified and liability-classified awards to certain of its employees and directors and accounts for the awards based on fair value measurement guidance. The estimated fair value of share-based compensation is amortized to expense over the vesting period. See Note 14 for further discussion of the accounting for share-based compensation.

Income from Continuing Operations Attributable to PFCB per Share

Basic income from continuing operations attributable to PFCB per share is computed based on the weighted average number of common shares outstanding during the period. Diluted income from continuing operations attributable to PFCB per share is computed based on the weighted average number of shares of common stock and potentially dilutive securities, which includes options, restricted stock and restricted stock units ("RSUs") outstanding under the Company’s equity plans and employee stock purchase plan. For the years ended January 1, 2012, January 2, 2011, and January 3, 2010, 1.1 million, 0.8 million, and 2.1 million, respectively, of the Company’s options were excluded from the calculation due to their anti-dilutive effect.

The following table sets forth the computation of basic and diluted income from continuing operations attributable to PFCB per share:



	Year Ended
	January 1, 2012		January 2, 2011		January 3, 2010
Numerator:
Income from continuing operations attributable to PFCB common stockholders, net of tax	$	30,140	$	46,562	$	43,676
Denominator:
Basic: Weighted-average shares outstanding during the year	21,831		22,689		22,986
Add dilutive effect of equity awards	273		426		427
Diluted	22,104		23,115		23,413
Income from continuing operations attributable to PFCB common stockholders per share:
Basic	$	1.38	$	2.05	$	1.90
Diluted	$	1.36	$	2.01	$	1.87

The Company began paying quarterly cash dividends to its shareholders during fiscal 2010. The Company's restricted stock awards are considered participating securities as the awards include non-forfeitable rights to dividends with respect to unvested shares and, as such, must be included in the computation of earnings per share pursuant to the two-class method. Under the two-class method, a portion of net income is allocated to participating securities, and therefore is excluded from the calculation of earnings per share allocated to common shares. For the years ended January 1, 2012 and January 2, 2011, the calculation of basic and diluted earnings per share pursuant to the two-class method resulted in an immaterial difference from the amounts displayed in the consolidated statements of income.

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, receivables, accounts payable and accrued expenses is deemed to approximate fair value due to the immediate or short-term maturity of these financial instruments. The fair value of long-term debt approximates the carrying value due to the Company’s right to repay outstanding balances at any time.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash investments and receivables. The Company maintains cash and cash equivalents, funds on deposit and certain other financial instruments with financial institutions that are considered in the Company’s investment strategy. Concentrations of credit risk with respect to receivables are limited as the Company’s receivables are primarily related to third-party gift card sales, rebates, tenant incentives from landlords and a long-term receivable under the loan facility to True Food Kitchen.

Derivatives

During the second quarter of 2008, the Company hedged a portion of its existing long-term variable-rate debt through the use of an interest rate swap. This derivative instrument effectively fixed the interest expense on a portion of the Company’s long-term debt for the duration of the swap. The interest rate swap expired on May 20, 2010. There was no hedge ineffectiveness recognized during the period ended January 2, 2011.

All derivatives were recognized on the balance sheet at fair value as liabilities in accrued expenses. The fair value of the Company’s derivative financial instruments was determined using either market quotes or valuation models that were based upon the net present value of estimated future cash flows and incorporated current market data inputs. The accounting for the change in the fair value of a derivative financial instrument depended on its intended use and the resulting hedge designation.

Recent Accounting Literature

Improving Disclosures about Fair Value Measurements (Accounting Standards Update ("ASU") No. 2010-06)

(Included in ASC 820 “Fair Value Measurement”)

ASU No. 2010-06 requires new disclosures regarding recurring or nonrecurring fair value measurements. Entities are required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy and describe the reasons for the transfers. Entities are required to provide information on purchases, sales, issuances and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. In addition, entities must provide fair value measurement disclosures for each class of assets and liabilities, and disclosures about the valuation techniques used in determining fair value for Level 2 or Level 3 measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the gross basis reconciliation for the Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010. The adoption of ASU 2010-06 did not have a material impact on the Company's consolidated financial statements. There were no transfers between Level 1 and Level 2 measurements in the fair value hierarchy during fiscal 2011.

Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU No. 2011-04)

(Included in ASC 820 “Fair Value Measurement”)

ASU No. 2011-04 amends existing guidance to provide common fair value measurements and related disclosure requirements between GAAP and International Financial Reporting Standards (“IFRS”). Additional disclosure requirements in the amendment include: (1) for Level 3 fair value measurements, a description of the valuation processes used by the entity and a discussion of the sensitivity of the fair value measurements to changes in unobservable inputs; (2) discussion of the use of a nonfinancial asset that differs from the asset's highest and best use; and (3) the level of the fair value hierarchy of financial instruments for items that are not measured at fair value but disclosure of fair value is required. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011 with early adoption not permitted. The Company will adopt ASU No. 2011-04 in fiscal 2012. The Company is currently evaluating the impact ASU No. 2011-04 will have on its consolidated financial statements.

Presentation of Comprehensive Income (ASU No. 2011-05)

(Included in ASC 220 “Comprehensive Income”)

ASU No. 2011-05 amends existing guidance to allow only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous statement of comprehensive income or (2) in two separate but consecutive financial statements consisting of an income statement followed by a statement of other comprehensive income. ASU No. 2011-05 requires retrospective application, and it is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 with early adoption permitted. The Company will adopt ASU No. 2011-05 in fiscal 2012 and does not anticipate any material impact on the Company's consolidated financial statements.

Testing Goodwill for Impairment (ASU No. 2011-08)

(Included in ASC 350 “Intangibles - Goodwill and Other”)

ASU No. 2011-08 is intended to simplify goodwill impairment testing. ASU No. 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than the carrying value before performing the two-step goodwill impairment test that exists currently. If it is determined through the qualitative assessment that a reporting unit's fair value is more likely than not greater than its carrying value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. ASU No. 2011-08 is effective for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company will adopt ASU No. 2011-08 in fiscal 2012 and is currently evaluating the option of the addition of a qualitative assessment in its goodwill impairment testing.