Floor & Decor Holdings, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Commitments and Contingencies

Commitments and Contingencies

12 Months Ended

Dec. 30, 2021

Commitments and Contingencies Disclosure [Abstract]

Lease Commitments

In the first quarter of fiscal 2019, the Company adopted ASU No. 2016-02, “Leases (Topic 842),” which requires that lessees recognize lease right-of-use assets and lease liabilities for all leases on the balance sheet with an option to exclude short-term leases (leases with terms of 12 months or less), which was elected. The Company adopted ASU No. 2016-02 using the modified retrospective approach and elected the package of practical expedients to use in transition, which permitted the Company to not reassess, under the new standard, prior conclusions about lease identification and lease classification. The cumulative effect adjustment upon adoption of ASU No. 2016-02 resulted in an immaterial adjustment to retained earnings. Additionally, the Company does not separate lease and nonlease components of contracts.

The majority of the Company’s long-term operating lease agreements are for its corporate office, retail locations, and distribution centers, which expire in various years through 2042. Most of these agreements are retail leases wherein both the land and building are leased. For a small number of retail locations, the Company has ground leases in which only the land is leased. The initial lease terms for the Company's corporate office, retail, and distribution center facilities generally range from 10-20 years. The majority of the Company’s retail and ground leases also include options to extend, which are factored into the recognition of their respective assets and liabilities when appropriate based on management’s assessment of the probability that the options will be exercised. Lease payments used in measurement of the lease liability typically do not include executory costs, such as taxes, insurance, and maintenance, unless those costs can be reasonably estimated at lease commencement. Additionally, one building lease contains variable lease payments, which are determined based on a percentage of retail sales over a contractual level, and the Company subleases real estate within one of its distribution centers to a third party. Certain of the lease agreements include escalating rents over the lease terms which, under Topic 842, results in rent being expensed on a straight-line basis over the life of the lease that commences on the date the Company has the right to control the property. The Company’s lease agreements do not contain any residual value guarantees or restrictive covenants that would reasonably be expected to have a material impact on the business.

When readily determinable, the rate implicit in the lease is used to discount lease payments to present value; however, substantially all of the Company’s leases do not provide a readily determinable implicit rate. If the rate implicit in the lease is not readily determinable, the Company uses a third party to assist in the determination of a secured incremental borrowing rate, determined on a collateralized basis, to discount lease payments based on information available at lease commencement. The secured incremental borrowing rate is estimated based on yields obtained from Bloomberg for U.S. consumers with a BB- credit rating and is adjusted for collateralization as well as inflation.

Lease Position

The table below presents supplemental balance sheet information related to operating leases.


in thousands, except lease term and discount rate	Classification	As of December 30, 2021		As of December 31, 2020
Assets
Building	Right-of-use assets	$	972,962	$	851,092
Land	Right-of-use assets	107,764		56,708
Equipment	Right-of-use assets	14,127		6,865
Software	Right-of-use assets	8,897		1,660
Total operating lease assets		1,103,750		916,325
Liabilities
Current
Building	Current portion of lease liabilities	92,909		88,287
Land	Current portion of lease liabilities	1,385		440
Equipment	Current portion of lease liabilities	6,842		3,941
Software	Current portion of lease liabilities	3,466		1,834
Total current operating lease liabilities		104,602		94,502
Noncurrent
Building	Lease liabilities	989,712		873,098
Land	Lease liabilities	120,174		65,103
Equipment	Lease liabilities	7,285		2,924
Software	Lease liabilities	3,819		—
Total noncurrent operating lease liabilities		1,120,990		941,125
Total operating lease liabilities		$	1,225,592	$	1,035,627

Weighted-average remaining lease term		11 years		11 years
Weighted-average discount rate		5.1%		5.3%

Lease Costs

The table below presents components of lease expense for operating leases.


		Fiscal Year Ended
in thousands	Classification	December 30, 2021		December 31, 2020		December 26, 2019
Fixed operating lease cost:	Selling and store operating	$	123,882	$	105,207	$	87,124
	Cost of sales	24,170		22,672		17,132
	Pre-opening	10,127		7,886		5,959
	General and administrative	4,359		4,118		2,272
Total fixed operating lease cost		$	162,538	$	139,883	$	112,487

Variable lease cost (1):	Selling and store operating	$	42,093	$	34,499	$	28,894
	Cost of sales	5,506		4,860		3,570
	Pre-opening	274		657		151
	General and administrative	310		151		5
Total variable lease cost		$	48,183	$	40,167	$	32,620

Sublease income	Cost of sales	(2,694)		(2,713)		(2,414)
Operating lease right-of-use asset impairment	General and administrative	—		—		4,136
Total operating lease cost (2)		$	208,027	$	177,337	$	146,829

(1)Includes variable costs for common area maintenance, property taxes, and insurance on leased real estate.

(2)Excludes short-term lease costs, which were immaterial for the fiscal years ended December 30, 2021, December 31, 2020, and December 26, 2019.

Undiscounted Cash Flows

Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 30, 2021 were as follows:


in thousands	Amount
2022	$	163,924
2023	170,295
2024	161,516
2025	151,944
2026	143,693
Thereafter	866,242
Total minimum lease payments (1) (2)	1,657,614
Less: amount of lease payments representing interest	432,022
Present value of future minimum lease payments	1,225,592
Less: current obligations under leases	104,602
Long-term lease obligations	$	1,120,990

(1)Future lease payments exclude approximately $72.6 million of legally binding minimum lease payments for operating leases signed but not yet commenced.

(2)Operating lease payments include $108.5 million related to options to extend lease terms that are reasonably certain of being exercised.

For the fiscal years ended December 30, 2021, December 31, 2020, and December 26, 2019, cash paid for operating leases was $157.9 million, $131.3 million, and $112.8 million, respectively.

Right-of-Use Asset Impairment and Write Off

During the third quarter of fiscal 2019, the Company began the move from its former store support center in Smyrna, Georgia to a nearby location in Atlanta, Georgia. Prior to this period, future payments under the operating lease agreement were expected to be fully covered with proceeds from a sublease. As of the end of the third quarter of fiscal 2019, the Company no longer expected to find a sublease tenant that would fully cover these future payments and concluded that the right-of-use asset related to the operating lease was not recoverable. Therefore, the fair value of the right-of-use asset was determined based on a discounted cash flow analysis reflective of the income expected from a sublease. Based on the excess of the asset’s carrying value over fair value, an impairment of $4.1 million was recognized in the third quarter of fiscal 2019 within general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income.

In addition, during the fourth quarter of fiscal 2019, the move to the new location was completed and the lease for the previous store support center facility in Smyrna, Georgia was terminated. As a result, a loss of $1.9 million was recognized related to the settlement of remaining obligations under the lease and the write off of the remaining right-of-use asset for the facility upon lease termination. This loss was recognized within general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income.

Litigation

On November 15, 2021, the Company was added as a defendant in a wrongful death lawsuit, Nguyen v. Inspections Now, Inc., No. 21-DCV-287142, pending in the 434th Judicial District Court of Fort Bend County, Texas. Inspections Now, Inc. and Jason Post Homes, LLC are also named defendants in the case. Plaintiff’s petition alleges that unspecified “wood paneling” allegedly purchased from the Company was installed in the vicinity of plaintiff’s fireplace and caught fire while the fireplace was lit. The fire consumed plaintiff’s home and resulted in injuries to plaintiff and the death of plaintiff’s three children and mother. Plaintiff alleges product defect and failure to warn claims against the Company and negligent inspection claims against Inspections Now and Jason Post Homes. Plaintiff’s petition seeks damages in excess of $1.0 million for property damage, personal injury, and wrongful death. The petition also seeks exemplary damages. The Company responded to Plaintiff’s petition on December 13, 2021, denying the allegations, and the case is in the early stages of discovery.

On June 18, 2020, an alleged stockholder filed a putative derivative complaint, Lincolnshire Police Pension Fund v. Taylor, et al., No. 2020-0487-JTL, in the Delaware Court of Chancery, purportedly on behalf of the Company against certain of the Company’s officers, directors, and stockholders. The complaint alleges breaches of fiduciary duties and unjust enrichment. The factual allegations underlying these claims are similar to the factual allegations made in the previously dismissed In re Floor & Decor Holdings, Inc. Securities Litigation. The complaint seeks unspecified damages and restitution for the Company from the individual defendants and the payment of costs and attorneys’ fees. The time for the defendants to respond to the complaint has not yet expired.

The Company maintains insurance that may cover any liability arising out of the above-referenced litigation up to the policy limits and subject to meeting certain deductibles and to other terms and conditions thereof. Estimating an amount or range of possible losses resulting from litigation proceedings is inherently difficult, particularly where the matters involve indeterminate claims for monetary damages and are in the stages of the proceedings where key factual and legal issues have not been resolved. For these reasons, the Company is currently unable to predict the ultimate timing or outcome of or reasonably estimate the possible losses or a range of possible losses resulting from the above-referenced litigation.

The Company is also subject to various other legal actions, claims and proceedings arising in the ordinary course of business, which may include claims related to general liability, workers’ compensation, product liability, intellectual property and employment-related matters resulting from its business activities. As with most actions such as these, an estimation of any possible and/or ultimate liability cannot always be determined. The Company establishes reserves for specific legal proceedings when it determines that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. These various other ordinary course proceedings are not expected to have a material impact on the Company's consolidated financial position, cash flows, or results of operations, however regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources, and other factors.