Floor & Decor Holdings Inc.

02/19/2026 | Press release | Distributed by Public on 02/19/2026 15:20

Annual Report for Fiscal Year Ending December 25, 2025 (Form 10-K)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes thereto and other financial information included elsewhere in this filing. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those discussed in Item 1A, "Risk Factors." See the cautionary note regarding forward-looking statements set forth at the beginning of this Annual Report.
Overview
Founded in 2000, Floor & Decor is a high-growth, differentiated, multi-channel specialty retailer of hard surface flooring and related accessories and seller of commercial surfaces with 270 warehouse-format stores across 39 states as of December 25, 2025. We believe our unique approach to selling hard surface flooring and our consistent and disciplined culture of innovation and reinvestment create a differentiated business model in the hard surface flooring category. We believe that we offer the broadest in-stock assortment of laminate and vinyl, tile, wood, and natural stone flooring and installation materials and decorative accessories, as well as adjacent categories, at everyday low prices. This positions us as the one-stop destination for our customers' entire hard surface flooring needs. We appeal to a variety of customers, including Pros and homeowners, which are comprised of DIY and BIY customers. Our warehouse-format stores, which average approximately 76,000 square feet, carry on average approximately 4,200 SKUs, approximately 1.0 million square feet of flooring products, and $2.7 million of inventory at cost as of December 25, 2025. We believe that our inspiring design centers and creative and informative visual merchandising also greatly enhance our customers' renovation experience. In addition to our stores, our website showcases our products.
The following table presents a performance summary of our results of operations for fiscal years 2025 and 2024:
Fiscal Year Ended
dollars in thousands December 25, 2025 December 26, 2024
Net sales $ 4,684,088 $ 4,455,770
Net income $ 208,647 $ 205,872
Adjusted EBITDA $ 538,171 $ 512,504
Comparable store sales (1.8) % (7.1) %
Number of warehouse-format stores 270 251
During fiscal 2025, we opened 20 new warehouse-format stores and closed one warehouse-format store, ending the year with 270 warehouse-format stores and five design studios. Additionally, we opened a new distribution center near Seattle, ending the year with five distribution centers.
The housing market continued to be impacted by a number of macroeconomic factors during fiscal 2025, including elevated interest rates and higher home prices putting pressure on housing affordability, which resulted in low existing home sales. We believe these factors directly contributed to a slowdown in demand for flooring resulting in a year-over-year decline in our comparable store sales. These factors, coupled with rising construction costs, have made it difficult to achieve new store initial sales and profitability targets compared with those opened in prior years. Consequently, our more recent new store classes are experiencing lower first year sales and initial returns compared to new stores opened in years prior to 2022. To optimize our return on investment, we focus on strategically reducing the construction costs and operating expenses. Despite these macroeconomic challenges, we believe that our continued focus on providing exceptional value to customers through our broad assortment and everyday low price strategy, while remaining disciplined to maintain profitability through cost control and strategic growth investments, have been instrumental in helping us to navigate this challenging housing market. However, the potential significance and duration of these macroeconomic difficulties is uncertain, and further pressures on the housing market could have an adverse impact on our business.
Key Performance Indicators
We consider a variety of performance and financial measures in assessing the performance of our business. The key measures we use to determine how our business is performing are comparable store sales, the number of new store openings, gross profit and gross margin, operating income, and EBITDA and Adjusted EBITDA.
Comparable Store Sales
Our comparable store sales growth is a significant driver of our net sales, profitability, cash flow, and overall business results. We believe that comparable store sales growth is generated by continued focus on providing a dynamic and expanding product assortment in addition to other merchandising initiatives, quality of customer service, enhancing sales and marketing strategies, improving visual merchandising and overall aesthetic appeal of our stores and our website, effectively serving our Pro customers, continued investment in store staff and infrastructure, and further integrating connected customer strategies and other key information technology enhancements.
Comparable store sales refer to period-over-period comparisons of our net sales at the time of sale among the comparable store base. A store is included in the comparable store sales calculation on the first day of the thirteenth full fiscal month following a store's opening, which is when we believe comparability has been achieved. Changes in our comparable store sales between two periods are based on net sales at the time of sale for stores that were in operation during both of the two periods. Any change in the square footage of an existing comparable store, including for remodels and relocations within the same primary trade area of the existing store being relocated, does not eliminate that store from inclusion in the calculation of comparable store sales. Stores that are closed for a full fiscal month or longer are excluded from the comparable store sales calculation for each full fiscal month that they are closed. Since our e-commerce, regional account manager, and design studio sales are fulfilled by individual stores, they are included in comparable store sales only to the extent the fulfilling store meets the above mentioned store criteria. Sales through our Spartan subsidiary do not involve our stores and are therefore excluded from the comparable store sales calculation. When a fiscal year includes a 53rd week, we exclude the 53rd week of sales from our calculation.
Definitions and calculations of comparable store sales differ among companies in the retail industry; therefore, comparable store metrics disclosed by us may not be comparable to the metrics disclosed by other companies.
We believe that comparable store sales is a useful measure as it allows management, analysts, investors, and other interested parties to evaluate the sales performance of our retail stores. In addition, comparable store sales highlights our sales and market share growth. Management uses comparable store sales to evaluate the effectiveness of our selling strategies, to make budgeting decisions, and to compare our performance against that of other peer companies using similar measures.
Number of New Stores
The number and timing of new store openings, and the costs and fixed lease obligations associated with those openings, have had, and are expected to continue to have, a significant impact on our results of operations. The number of new stores reflects the number of stores opened during a particular reporting period. Before we open new stores, we incur operating expenditures, which are defined as pre-opening expenses. The majority of pre-opening expenses are incurred during the three months before a store opens. A new store's operating performance is excluded from the comparable store base until the first day of the thirteenth full fiscal month following a store's opening. Net sales at new stores are generally lower than net sales at our stores that have been open for more than one year. Our ability to open new, profitable stores is important to our long-term sales and profit growth goals.
Gross Profit and Gross Margin
Our gross profit is variable in nature and generally follows changes in net sales. Our gross profit and gross margin can also be impacted by changes in our prices, our merchandising assortment, customer preferences, shrink, damage, selling of discontinued products, the cost to transport our products from the manufacturer to our stores, and our distribution center costs. With respect to our merchandising assortment, certain of our products generate higher margins than other products within the same product categories or among different product categories. Our gross profit and gross margin, which reflect our net sales and our cost of sales and any changes to the components thereof, allow us to evaluate our profitability and overall business results.
Gross profit is calculated as net sales less cost of sales. Gross profit as a percentage of net sales is referred to as gross margin. Cost of sales consists of merchandise costs, as well as freight costs to transport inventory to our distribution centers and stores, and duty and other costs that are incurred to distribute the merchandise to our stores. Cost of sales also includes costs for shrink, damage, warehousing, sourcing, and compliance. We receive cash consideration from certain vendors related to vendor allowances and volume rebates, which is recorded as a reduction of costs of sales as the inventory is sold or as a reduction of the carrying value of inventory while the inventory is still on hand. Costs associated with arranging and paying for freight to deliver products to customers is included in cost of sales. The components of our cost of sales may not be comparable to the components of cost of sales, or similar measures, of other retailers. As a result, data in this filing regarding our gross profit and gross margin may not be comparable to similar data made available by other retailers.
We believe that gross profit and gross margin are useful measures as they allow management and analysts, investors, and other interested parties to evaluate the cost and profitability of our products and overall cost of sales, which is our largest expense. Management uses gross profit and gross margin, among other measures, to make decisions related to product, pricing, supplier, and distribution strategies as well as other areas affecting the products we offer to our customers.
Operating Income, EBITDA, and Adjusted EBITDA
Operating income, EBITDA, and Adjusted EBITDA are key metrics used by management and our Board to assess our financial performance and enterprise value. We believe that operating income is a useful measure as it is an indicator of the productivity of our business and our ability to manage expenses. We also believe that EBITDA and Adjusted EBITDA are useful measures, as they eliminate certain expenses that are not indicative of our core operating performance and facilitate comparisons on a consistent basis from period to period. We also use Adjusted EBITDA as a basis to determine covenant compliance with respect to our Credit Facilities, to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, and to compare our performance against that of other peer companies using similar measures. Operating income, EBITDA, and Adjusted EBITDA are also frequently used by analysts, investors, and other interested parties as performance measures to evaluate companies in our industry.
EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by or presented in accordance with GAAP. We define EBITDA as net income before interest, taxes, and depreciation and amortization. We define Adjusted EBITDA as net income before interest, taxes, and depreciation and amortization adjusted to eliminate the impact of non-cash stock-based compensation expense and certain items that we do not consider indicative of our core operating performance.
EBITDA and Adjusted EBITDA are non-GAAP measures of our financial performance and should not be considered as alternatives to net income as a measure of financial performance or any other performance measure derived in accordance with GAAP, and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Additionally, EBITDA and Adjusted EBITDA are not intended to be measures of liquidity or free cash flow for management's discretionary use. In addition, these non-GAAP measures exclude certain non-recurring and other charges. Each of these non-GAAP measures has its limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. In evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the items eliminated in the adjustments made to determine EBITDA and Adjusted EBITDA, such as stock-based compensation expense, litigation settlement recovery, fair value adjustments related to contingent earn-out liabilities, and other adjustments. Definitions and calculations of EBITDA and Adjusted EBITDA differ among companies in the retail industry, and therefore EBITDA and Adjusted EBITDA disclosed by us may not be comparable to the metrics disclosed by other companies.
Other Key Financial Definitions
Net Sales
Net sales reflect our sales of merchandise, less discounts and estimated returns, and include our in-store sales, connected customer sales, and commercial sales. In certain cases, we arrange and pay for freight to deliver products to customers and bill the customer for the estimated freight cost, which is also included in net sales. Revenue is recognized when we satisfy the performance obligations in contracts with our customers, which is typically when the customer obtains control of the underlying inventory.
The retail and commercial sectors in which we operate are cyclical, and consequently our sales are affected by general economic conditions. Purchases of our products are sensitive to trends in the levels of consumer spending, which are affected by a number of factors such as consumer disposable income, housing market conditions, unemployment trends, stock market performance, consumer debt levels and consumer credit availability, interest rates and inflation, tax rates, and overall consumer confidence in the economy.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses consist primarily of store and store support center wages, incentive compensation and benefits, store and store support center occupancy costs, depreciation and amortization, advertising costs, credit card fees, pre-opening costs, information technology costs, and other miscellaneous operating costs. We expect that our SG&A expenses will increase in future periods with future growth. SG&A expenses include variable as well as fixed components, which may not directly correlate with net sales. The components of our SG&A expenses may not be comparable to the components of similar measures of other retailers.
Segments
We have two operating segments and one reportable segment. For additional segment information, refer to Note 14, "Segment Reporting" of the notes to the consolidated financial statements included in this Annual Report.
Results of Operations
The comparison of the fiscal years ended December 26, 2024 and December 28, 2023 can be found in our annual report on Form 10-K for the fiscal year ended December 26, 2024 (the "2024 Annual Report") located within Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Results of operations for any period should not be considered indicative of future results. For information about the potential impacts that risks, such as declines in economic conditions that affect the residential housing market and consumer spending for hard surface flooring, interest rates, inflation, global supply chain disruptions, regulatory and political conditions, tariffs and trade policy, and geopolitical instability, among others, may have on our results of operations and overall financial performance for future periods, see "Overview" further above and Item 1A, "Risk Factors" in Part I of this Annual Report.
The following tables summarize key components of our results of operations for the periods indicated:
Fiscal Year Ended
December 25, 2025 December 26, 2024 Increase (Decrease)
dollars in thousands
Amount
% of Net Sales
Amount
% of Net Sales
$ %
Net sales $ 4,684,088 100.0 % $ 4,455,770 100.0 % $ 228,318 5.1 %
Cost of sales 2,640,180 56.4 2,527,519 56.7 112,661 4.5 %
Gross profit 2,043,908 43.6 1,928,251 43.3 115,657 6.0 %
Selling, general and administrative expenses
1,773,838 37.8 1,672,075 37.5 101,763 6.1 %
Operating income 270,070 5.8 256,176 5.8 13,894 5.4 %
Interest expense, net 3,409 0.1 2,773 0.1 636 22.9 %
Income before income taxes 266,661 5.7 253,403 5.7 13,258 5.2 %
Income tax expense
58,014 1.2 47,531 1.1 10,483 22.1 %
Net income $ 208,647 4.5 % $ 205,872 4.6 % $ 2,775 1.3 %
Fiscal Year Ended
December 25, 2025 December 26, 2024
Comparable store sales (1.8) % (7.1) %
Comparable average ticket 1.8 % (2.5) %
Comparable transactions
(3.5) % (4.7) %
Number of warehouse-format stores
270 251
Adjusted EBITDA (in thousands) (1)
$ 538,171 $ 512,504
Adjusted EBITDA (% of net sales) (1)
11.5 % 11.5 %
(1)Refer to "Reconciliation of Non-GAAP Financial Measures" further below for a reconciliation of Adjusted EBITDA to net income.
Net Sales
Net sales during fiscal 2025 increased $228.3 million, or 5.1%, compared to fiscal 2024 primarily due to sales from the 20 new warehouse-format stores that we opened during the year, partially offset by a decrease in comparable store sales of 1.8%. The comparable store sales decline during the period of 1.8%, or $77.4 million, was due to a 3.5% decrease in comparable transactions, partially offset by a 1.8% increase in comparable average ticket. We believe the decrease in comparable transactions was largely driven by the continued impact of low existing home sales. The increase in comparable average ticket was primarily due to changes in sales mix. Non-comparable sales increased $305.7 million compared to fiscal 2024 primarily driven by new stores.
We estimate that retail sales during both fiscal 2025 and fiscal 2024 were approximately 50% from homeowners and 50% from Pros.
Gross Profit and Gross Margin
Gross profit during fiscal 2025 increased $115.7 million, or 6.0%, compared to fiscal 2024. The increase in gross profit was primarily driven by the 5.1% increase in net sales and an increase in gross margin to 43.6%, up approximately 30 basis points from 43.3% in fiscal 2024. The increase in gross margin was primarily driven by favorable product margin due to a decrease in supply chain costs, partially offset by an increase in distribution center costs.
Selling, General and Administrative Expenses
SG&A expenses during fiscal 2025 increased $101.8 million, or 6.1%, compared to fiscal 2024. The increase in SG&A expenses was primarily driven by the 20 new stores that we opened during the year, which increased compensation costs, occupancy costs, and depreciation and amortization expense. SG&A expenses for non-comparable stores increased $126.8 million and for comparable stores decreased $24.8 million. As a percentage of net sales, SG&A expenses increased by approximately 30 basis points to 37.8% from 37.5% in fiscal 2024. This increase was primarily attributable to the addition of new stores and deleverage from a decrease in comparable store sales, partially offset by a decrease in pre-opening expenses.
Interest Expense, Net
Net interest expense during fiscal 2025 increased $0.6 million, or 22.9%, compared to fiscal 2024 primarily due to a decrease in capitalized interest, partially offset by lower average interest rates and lower average outstanding borrowings.
Income Tax Expense
Income tax expense was $58.0 million in fiscal 2025 compared to $47.5 million in fiscal 2024. The effective tax rate was 21.8% for fiscal 2025 compared to 18.8% for fiscal 2024. The effective tax rate increase was primarily due to a decrease in excess tax benefits related to stock-based compensation awards.
Reconciliation of Non-GAAP Financial Measures
EBITDA and Adjusted EBITDA
For the periods presented, the following table reconciles EBITDA and Adjusted EBITDA to net income, the most directly comparable financial measure calculated and presented in accordance with GAAP:
Fiscal Year Ended
in thousands December 25, 2025 December 26, 2024
Net income $ 208,647 $ 205,872
Depreciation and amortization (1)
238,971 230,293
Interest expense, net 3,409 2,773
Income tax expense 58,014 47,531
EBITDA 509,041 486,469
Stock-based compensation expense (2)
29,505 33,695
Litigation settlement recovery (3)
- (6,794)
Other (4)
(375) (866)
Adjusted EBITDA $ 538,171 $ 512,504
(1)Excludes amortization of deferred financing costs, which is included as part of interest expense, net.
(2)Represents non-cash charges related to stock-based compensation programs, which vary from period to period depending on the timing of awards and forfeitures.
(3)Represents net proceeds received related to the derivative litigation settlement in fiscal 2024.
(4)Other adjustments include amounts management does not consider indicative of our core operating performance. Amounts for both fiscal 2025 and fiscal 2024 relate to changes in the fair value of contingent earn-out liabilities.
Liquidity and Capital Resources
Liquidity is provided primarily by cash flows from operations and our $800.0 million ABL Facility. Unrestricted liquidity as of December 25, 2025 was $909.8 million, consisting of $249.3 million in cash and cash equivalents and $660.5 million immediately available for borrowing under the ABL Facility without violating any covenants thereunder. Our liquidity is generally not seasonal.
Our primary cash needs are for merchandise inventories, payroll, store rent, and other operating expenses and capital expenditures associated with opening new stores and remodeling existing stores as well as information technology, e-commerce, store support center, and distribution center infrastructure. We also use cash for the payment of taxes and interest and, as applicable, acquisitions. We expect that cash generated from operations together with cash on hand, the availability of borrowings under our Credit Facilities, and if necessary, additional funding through other forms of external financing, will be sufficient to meet liquidity requirements, anticipated capital expenditures, and payments due under our Credit Facilities for the next twelve months and the foreseeable future.
Total capital expenditures in fiscal 2026 are planned to be between approximately $250 million to $300 million and are expected to be funded primarily by cash generated from operations. Our capital needs may change in the future due to changes in our business, new opportunities that we choose to pursue, or other factors. We currently expect the following for capital expenditures in fiscal 2026:
•invest approximately $160 million to $190 million to open 20 warehouse-format stores, relocate stores, and begin construction on stores opening after fiscal 2026;
•invest approximately $60 million to $70 million in existing stores and new and existing distribution centers; and
•invest approximately $30 million to $40 million in information technology infrastructure, e-commerce, and other store support center initiatives.
Cash Flow Analysis
A summary of our operating, investing, and financing activities is shown in the following table:
Fiscal Year Ended
in thousands
December 25, 2025 December 26, 2024
Net cash provided by operating activities
$ 381,836 $ 603,155
Net cash used in investing activities
(317,764) (446,826)
Net cash used in financing activities
(2,445) (3,042)
Net increase in cash and cash equivalents
$ 61,627 $ 153,287
Net Cash Provided by Operating Activities
Cash provided by operating activities consists primarily of (i) net income adjusted for non-cash items, including depreciation and amortization, stock-based compensation, and deferred income taxes and (ii) changes in working capital.
Net cash provided by operating activities was $381.8 million for fiscal 2025 and $603.2 million for fiscal 2024. The decrease in net cash provided by operating activities was primarily driven by changes in trade accounts payable.
Net Cash Used in Investing Activities
Investing activities typically consist primarily of capital expenditures for new store openings and existing store remodels, including leasehold improvements, racking, fixtures, vignettes, design centers, and new infrastructure and information systems. Cash payments to acquire businesses are also included in investing activities.
Net cash used in investing activities was $317.8 million for fiscal 2025 and $446.8 million for fiscal 2024. The decrease in net cash used in investing activities was due to a decrease in capital expenditures primarily driven by a decrease in new stores under construction.
Net Cash Used in Financing Activities
Financing activities consist primarily of borrowings and related repayments under our Credit Facilities, tax payments related to the vesting or exercise of stock-based compensation awards, proceeds from the exercise of stock options and our employee stock purchase program, and payments of contingent earn-out consideration.
Net cash used in financing activities was $2.4 million for fiscal 2025 and $3.0 million for fiscal 2024.
Our Credit Facilities
As of December 25, 2025, total Term Loan Facility debt outstanding was $198.2 million, and no amounts were outstanding under our ABL Facility. For additional information regarding our Term Loan Facility and ABL Facility, including applicable covenants and other details, please refer to Note 10, "Debt" of the notes to the consolidated financial statements included in this Annual Report.
Credit Ratings
Our credit ratings are periodically reviewed by rating agencies. As of December 25, 2025, our Standard & Poor's issuer credit rating of BB with a stable outlook and Moody's issuer credit rating of Ba3 with a stable outlook remain unchanged from December 26, 2024. These ratings and our current credit condition affect, among other things, our ability to access new capital. Negative changes to these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, financial condition, results of operations, and liquidity. In particular, a weakening of our financial condition, including an increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing.
Material Cash Requirements, including Contractual Obligations to Third Parties
We enter into long-term obligations and commitments in the normal course of business, primarily non-cancelable operating leases and debt obligations. Our material cash requirements over the next several periods from known contractual or other obligations as of December 25, 2025 are described below.
Operating Leases.We enter into operating leases during the normal course of business. Most lease arrangements provide us with the option to renew the leases at defined terms. The future operating lease obligations would change if we were to exercise these options or enter into additional operating leases. Refer to Note 9, "Commitments and Contingencies" of the notes to our consolidated financial statements included in this Annual Report for a summary of our operating lease obligations as of December 25, 2025.
Debt.Refer to Note 10, "Debt" of the notes to our consolidated financial statements included in this Annual Report for a summary of our long-term debt obligations as of December 25, 2025.
Purchase Obligations.Purchase obligations include agreements to purchase goods or services that are legally binding and non-cancelable. Our purchase obligations primarily relate to certain software and license commitments, advertising programs, and enterprise resource planning costs. The reported amounts exclude liabilities included in our Consolidated Balance Sheet. As of December 25, 2025, purchase obligations totaled $63.4 million, of which $36.4 million is due within 12 months. We issue inventory purchase orders in the normal course of business, which are typically cancellable by their terms and are excluded from the amounts above.
Performance Guarantees. In the ordinary course of business, we are required to post letters of credit as financial guarantees of our performance. As of December 25, 2025, letters of credit totaled $38.1 million. We do not currently provide cash collateral for outstanding letters of credit. We have negotiated a letter of credit sublimit as part of our ABL Facility. The amount available to be borrowed under our ABL Facility is reduced by the cumulative amount of any outstanding letters of credit.
Off-Balance Sheet Arrangements. For fiscal 2025, we were not party to any material off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, net sales, expenses, results of operations, liquidity, capital expenditures, or capital resources. We do not have any relationship with unconsolidated entities or financial partnerships for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes.
U.S. Tariffs and Global Economy
The current geopolitical environment, particularly related to existing and potential changes in global trade and tariffs, has created uncertainty surrounding the future state of the global economy and related impacts to our supply chain. In 2025, the U.S. imposed significant additional tariffs on products from most countries where we source products. Although the U.S. has agreed to trade deals or frameworks for trade deals with certain countries and continues to negotiate with other countries, the timing of implementation and stability of these trade deals are unclear. Additionally, if the U.S. implements further tariffs, countries where we source products may impose new tariffs and other trade measures on the U.S. in response, resulting in potentially escalating trade conflict between the U.S. and its trading partners.
As we continue to manage the impact these tariffs may have on our business and the complexities of the various trade policy actions, we continue taking steps to mitigate some of the cost increases through negotiations with our vendors, sourcing from alternative countries, and increasing retail pricing as we deem appropriate. While we continue to take steps to mitigate the overall effect of increased tariffs, these tariffs have increased and will continue to increase our inventory costs and associated cost of sales, which have resulted in and in the future may result in increased retail prices and may adversely impact sales. Furthermore, the broader impact of increased tariffs on the economy has and in the future may negatively impact consumer demand for our products, which may also have an adverse impact on sales.
Recently Adopted and Recently Issued Accounting Pronouncements
Refer to Note 1, "Summary of Significant Accounting Policies" of the notes to the consolidated financial statements included in this Annual Report for information on the recently adopted and recently issued accounting pronouncements that are applicable to the Company.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions about future events that affect amounts reported in our consolidated financial statements and related notes as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. Management evaluates its accounting policies, estimates, and judgments on an ongoing basis. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ under different assumptions and conditions, and such differences could be material to the consolidated financial statements.
Management evaluated the development and selection of its critical accounting policies and estimates and believes that the following accounting policies are critical as they involve a higher degree of judgment or complexity and are the most significant to reporting our results of operations and financial position. The following critical accounting policies reflect the significant estimates and judgments used in the preparation of our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected experience can potentially have a materially favorable or unfavorable impact on subsequent results of operations. All of our significant accounting policies are discussed in Note 1, "Summary of Significant Accounting Policies" of the notes to our audited consolidated financial statements included in this Annual Report.
Revenue Recognition
Description.We recognize revenue and the related cost of sales when we satisfy the performance obligations in contracts with our customers in accordance with Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers("ASC 606"). 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 typically the point at which the customer obtains control of the inventory. In some cases, merchandise is not physically ready for transfer to the customer at the point-of-sale, and revenue recognition is deferred until the customer has control of the inventory. Shipping and handling activities are accounted for as activities to fulfill the promise to transfer goods rather than as separate performance obligations as outlined within ASC 606. Payment is generally due from the customer immediately at the point-of-sale for both retail store sales and website sales with the exception of a small number of commercial clients purchasing through our commercial credit program, which typically offers longer payment terms.
Judgments and uncertainties involved in the estimate.Our customers have the right to return the goods sold to them within a reasonable time period, typically 90 days. The right of return is an element of variable consideration as defined within ASC 606. We estimate a reserve for future returns of previously sold goods based on historical experience and various other assumptions that we believe to be reasonable. Merchandise exchanges of similar product and price are not considered merchandise returns and, therefore, are excluded when calculating the sales returns reserve. While we believe that our current sales returns reserves are adequate, there can be no assurances that historical data and trends will accurately predict returns or that future developments might not lead to a significant change in the reserve.
Effect if actual results differ from assumptions. A 10% change in our sales returns reserves and related return asset accruals at December 25, 2025 would have had a net impact of approximately $1.4 million on operating income in fiscal 2025. Sales returns reserves and related return asset accruals over the last few years have fluctuated primarily based on changes in sales levels and, to a lesser extent, changes in customer return rates.
Merchandise Inventories
Description.Inventories consist of merchandise held for sale and are stated at the lower of cost or net realizable value. When evidence exists that the net realizable value of inventory is lower than its cost, the difference is recorded in cost of sales in the Consolidated Statements of Operations and Comprehensive Income as a loss in the period in which it occurs. We determine inventory costs using the moving weighted average cost method. We capitalize transportation, duties, and other costs to get product to our retail locations.
Judgments and uncertainties involved in the estimate.We provide provisions for losses related to shrink, net realizable value, aged inventory, special order merchandise, and other amounts that are otherwise not expected to be fully recoverable. These provisions are calculated based on historical shrink, selling prices, margins, and current business trends. The estimates have calculations that require management to make assumptions based on the current rate of sales, age, salability and profitability of inventory, historical percentages that can be affected by changes in our merchandising mix, customer preferences, and changes in actual shrink trends.
Effect if actual results differ from assumptions.A 10% change in our inventory valuation and shrink reserves at December 25, 2025 would have affected operating income by approximately $1.8 million in fiscal 2025. Inventory valuation and shrink reserves typically fluctuate in proportion to changes in inventory balances.
Vendor Rebates and Allowances
Description.Vendor allowances consist primarily of volume rebates that are earned as a result of reaching certain inventory purchase levels and advertising allowances or incentives for the promotion of vendors' products. These vendor allowances are accrued as earned and are estimated based on annual projections. Vendor allowances earned are initially recorded as a reduction to the carrying value of inventory and a subsequent reduction in cost of sales when the related product is sold. Certain incentive allowances that are reimbursements of specific, incremental, and identifiable costs incurred to promote vendors' products are recorded as an offset against these promotional expenses.
Judgments and uncertainties involved in the estimate.For vendor allowances, we develop accrual rates based on the provisions of the agreements in place. We perform analyses and review historical purchase trends and volumes throughout the year, adjust accrual rates as appropriate, and confirm actual amounts with select vendors to ensure the amounts earned are appropriately recorded. Amounts accrued throughout the year could be impacted if actual purchase volumes differ from projected purchase volumes, especially in the case of programs that provide for increased funding when graduated purchase volumes are met.
Effect if actual results differ from assumptions.If actual results are not consistent with the assumptions and estimates used, we could be exposed to additional adjustments that could positively or negatively impact gross margin and inventory. However, substantially all receivables associated with vendor rebates and allowances do not require subjective long-term estimates because they are collected soon after each quarter end, primarily within the first two months. Adjustments to gross margin and inventory in the following fiscal year have historically not been material.
Leases
Description.We recognize lease assets and corresponding lease liabilities for all operating leases on our Consolidated Balance Sheets, excluding short-term leases (leases with terms of 12 months or less) as described under ASC 842, Leases("ASC 842"). The majority of our long-term operating lease agreements include options to extend, which are also 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 are discounted using the rate implicit in the lease, or, if not readily determinable, a third-party secured incremental borrowing rate 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. Additionally, certain of our lease agreements include escalating rents over the lease terms, which, under ASC 842, results in rent being expensed on a straight-line basis over the life of the lease that commences on the date we have the right to control the property.
Judgments and uncertainties involved in the estimate.The determination of an appropriate secured incremental borrowing rate requires judgments in selecting an appropriate yield curve and estimating adjustments for collateralization and inflation.
Effect if actual results differ from assumptions.Based on the volume of new store leases that we enter into each year, a significant increase or decrease in the incremental borrowing rates used to discount lease payments could have a significant impact on the value of operating lease liabilities and right-of-use assets subsequently reported on our Consolidated Balance Sheets.
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