1. Summary of Significant Accounting Policies
Nature of Business
Floor & Decor Holdings, Inc., together with its subsidiaries (the “Company,” “we,” “our” or “us”) is a highly differentiated, rapidly growing specialty retailer of hard surface flooring and related accessories. We offer a broad in stock assortment of tile, wood, laminate and natural stone flooring along with decorative and installation accessories at everyday low prices. Our stores appeal to a variety of customers, including professional installers and commercial businesses (“Pro”), Do It Yourself customers (“DIY”) and customers who buy the products for professional installation (“Buy it Yourself” or “BIY”). We operate within one reportable segment.
As of September 27, 2018, the Company, through its wholly owned subsidiary, Floor and Decor Outlets of America, Inc. (“F&D”), operates 95 warehouse-format stores, which average 75,000 square feet, and one small-format standalone design center in 26 states, as well as three distribution centers and an e-commerce site, FloorandDecor.com.
The Company’s fiscal year is the 52- or 53-week period ending on the Thursday on or preceding December 31st. Fiscal years ended December 27, 2018 (“fiscal 2018”) and December 28, 2017 (“fiscal 2017”) include 52 weeks. When a 53-week fiscal year occurs, we report the additional week at the end of the fiscal fourth quarter. 52-week fiscal years consist of thirteen-week periods in the first, second, third and fourth quarters of the fiscal year.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and our wholly owned subsidiaries. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. The Condensed Consolidated Balance Sheet as of December 28, 2017 has been derived from the audited Consolidated Balance Sheet for the fiscal year then ended. The interim condensed consolidated financial statements should be read together with the audited consolidated financial statements and related footnote disclosures included in the Company’s Annual Report on Form 10-K for fiscal 2017, filed with the Securities and Exchange Commission (the “SEC”) on March 5, 2018 (the “Annual Report”). Unless indicated otherwise, the information in this quarterly report on Form 10-Q (the “Quarterly Report”) has been adjusted to give effect to a 321.820-for-one stock split of the Company’s outstanding common stock, which was approved by the Company’s board of directors and shareholders on April 13, 2017 and effected on April 24, 2017. Certain prior year amounts have been reclassified in the consolidated financial statements to conform to the current year presentation.
Management believes the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments considered necessary for a fair statement of results for the interim periods presented.
Results of operations for the thirteen and thirty-nine weeks ended September 27, 2018 and September 28, 2017 are not necessarily indicative of the results to be expected for the full year.
We recognize revenue and the related cost of sales when we satisfy the performance obligations in contracts with our customers. Our performance obligations for our retail store sales as well as for orders placed through our website and shipped to our customers are satisfied at the point-of-sale, which is the point at which the customer obtains control of the inventory as described under Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers” (Topic 606). Shipping and handling activities are performed after the customer obtains control of the goods and are accounted for as activities to fulfill the promise to transfer goods, rather than a separate performance obligation as outlined within Topic 606. Payment is due from the customer immediately at the point-of-sale for both retail store sales and website sales. The nature of the goods offered include hard surface flooring and related accessories. We do not perform installation services, and we offer free design services in-store. The transaction price recognized in revenues represents the selling price of the products offered. Sales taxes collected are not recognized as revenue as these amounts are ultimately remitted to the appropriate taxing authorities.
Our customers have the right to return the goods sold to them within a reasonable period, typically ninety days. The right of return is an element of variable consideration as defined within Topic 606. We reserve for future returns of previously sold goods based on historical experience and various other assumptions that we believe to be reasonable. This reserve reduces sales and cost of sales as well as establishes a return asset and refund liability as defined with ASC 606. For the period ended September 27, 2018, the return asset is included within Prepaid expenses and other current assets and the refund liability is included within Accrued expenses and other current liabilities, each respectively on the Condensed Consolidated Balance Sheets. We adopted the standard using the modified retrospective transition method within ASC 606; therefore, we accounted for the return asset and all provisions of ASC 606 prospectively. The return asset is included in Inventories, net on the December 28, 2017 Condensed Consolidated Balance Sheets. The refund liability under ASC 605 and ASC 606 is included within Accrued expenses and other current liabilities. Merchandise exchanges of similar product and price are not considered merchandise returns and, therefore, are excluded when calculating the sales returns reserve.
Gift Cards and Merchandise Credits
We sell gift cards to our customers in our stores and through our website and issue merchandise credits in our stores. We account for the programs by recognizing a liability at the time the gift card is sold or the merchandise credit is issued. The liability is relieved and revenue is recognized upon redemption. Additionally, we recognize breakage income in proportion to the pattern of rights exercised by the customer when we expect to be entitled to breakage. Net sales related to the estimated breakage are included in net sales in the Condensed Consolidated Statements of Income. We have an agreement with an unrelated third-party who is the issuer of our gift cards and also assumes the liability for unredeemed gift cards. We are not subject to claims under unclaimed property statutes, as the agreement effectively transfers the ownership of such unredeemed gift cards and the related future escheatment liability, if any, to the third-party. Accordingly, in the thirty-nine weeks ended September 27, 2018 and September 28, 2017, gift card breakage income of $1,340 thousand and $568 thousand, respectively was recognized in net sales in the Condensed Consolidated Statements of Income for such unredeemed gift cards.
Accounting for Income Taxes on GILTI
The Tax Cuts and Jobs Act subjects a U.S. shareholder to tax on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred. We have elected to recognize the resulting tax on GILTI as a period expense in the period the tax is incurred. However, we do not expect to incur tax for the period ending December 27, 2018.
There have been no other additional updates to our Significant Accounting Policies since the Annual Report. For information regarding our Significant Accounting Policies and Estimates, see the “Summary of Significant Accounting Policies” section of “Item 8. Financial Statements and Supplementary Data” of our Annual Report.
Recently Issued Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, "Leases (Topic 842)." ASU No. 2016-02 requires that lessees recognize lease assets and lease liabilities for all leases with greater than 12 month terms on the balance sheet. The guidance also requires disclosures about the amount, timing and uncertainty of cash flows arising from leases. This new guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. We will adopt the ASU on December 28, 2018, the first day of our fiscal year 2019, using the modified retrospective approach We will utilize a new lease accounting software to facilitate implementation. We are currently testing the software and are in the process of identifying any changes to our business processes and controls to support adoption of the new standard. We plan to elect the package of practical expedients upon transition that will retain the lease classification and initial direct costs for any leases that exist prior to adoption of the standard. Management is progressing with the implementation, but we are still evaluating the impact that ASU No. 2016-02 will have on our Consolidated Financial Statements. We currently believe that when implemented, the new standard will have a material impact on our Consolidated Balance Sheet, but we do not believe adoption of this standard will have a material impact on our Consolidated Statements of Income or Statements of Cash Flows.
There have been no other updates to Recently Issued Accounting Pronouncements since the Annual Report. For information regarding Recently Issued Accounting Pronouncements, see the “Summary of Significant Accounting Policies” section of “Item 8. Financial Statements and Supplementary Data” of our Annual Report.
Recently Adopted Accounting Pronouncements
In October 2016, the FASB issued ASU No. 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory." This standard update requires an entity to recognize the income tax consequences of intra-entity transfers of assets other than inventory when the transfer occurs. ASU No. 2016-16 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The amendments in this update should be applied using a modified retrospective approach. The adoption of ASU No. 2016-16 in the first quarter of fiscal 2018 did not have a material impact on the Company's Consolidated Financial Statements.
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." The standard update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The amendments in this update should be applied using a retrospective approach. The adoption of ASU No. 2016-15 in the first quarter of fiscal 2018 did not have a material impact on the Company's Consolidated Statements of Cash Flows.
In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers." ASU No. 2014-09 provides new guidance related to the core principle that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to receive in exchange for those goods or services provided. We adopted this standard using the modified retrospective approach in the first quarter of fiscal 2018, effective December 29, 2017. Under the new guidance, we recognize revenue at the time the customer obtains control of the inventory. The cumulative adjustment upon adoption primarily resulted in a reduction of deferred revenue and related inventories and an increase to retained earnings. The adoption of ASU No. 2014-09 did not have a material impact to the Company’s Consolidated Financial Statements.