Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with our consolidated and combined financial statements and the related notes thereto contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under Item 1A, “Risk Factors” and elsewhere in this report.
Set forth below is a comparison of the results of operations and changes in financial condition for the fiscal years ended April 30, 2021 and 2020. The comparison of, and changes between, the fiscal years ended April 30, 2020 and 2019 can be found within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Registration Statement on Form 10 for the fiscal year ended April 30, 2020 filed with the SEC on July 2, 2020, as amended by Amendment No.1, filed on July 13, 2020.
Background
On August 24, 2020, Smith & Wesson Brands, Inc., or our former parent company, completed the spin-off of its outdoor products and accessories business to us, or the Separation. The Separation was effected through the transfer of all of the assets and legal entities, subject to any related liabilities, associated with its outdoor products and accessories business to us, or the Transfer, and the distribution of all the outstanding shares of our common stock to the holders of the common stock of our former parent company, or the Distribution, as of the close of business on August 10, 2020, the record date for the Distribution, or the Record Date.
As a result of the Distribution, we became an independent public company and our common stock became listed under the symbol “AOUT” on the Nasdaq Global Select Market. Prior to the Separation, the combined financial statements reflected the financial position, results of operations, and cash flows for the periods presented as historically managed by our former parent. For those periods prior to the Separation, the combined financial statements were prepared on a “carve-out” basis as described below.
We operate as one reporting segment. We analyze revenue streams in various ways, including class of trade, brands, and customer channels. However, this information does not include a full set of discrete financial information.
Basis of Presentation
Our financial statements for the periods through the Separation date of August 24, 2020 are combined financial statements prepared on a “carve-out” basis as discussed below. Our financial statements for the period from August 24, 2020 through April 30, 2021 are consolidated financial statements based on the reported results of our company as a standalone company. Accordingly, the period subsequent to the Separation in fiscal 2021 included consolidated and combined financial statements, while all prior periods included combined financial statements.
Prior to the Separation, we operated as part of our former parent and not as a standalone company. The accompanying combined financial statements, prior to the Separation, were prepared in connection with the Separation and were derived from the consolidated financial statements and accounting records of our former parent. The combined financial statements, prior to the Separation, reflect our historical financial position, results of operations, and cash flows as they were historically managed in accordance with accounting principles generally accepted in the United States, or GAAP.
In addition, for purposes of preparing the combined financial statements, prior to the Separation, on a “carve-out” basis, a portion of our former parent’s total corporate expenses were allocated to us. These expense allocations included the cost of corporate functions and resources provided by our former parent, including executive management, finance, accounting, legal, human resources, internal audit, and the related benefit costs associated with such functions, such as stock-based compensation and the cost of our former parent’s Springfield, Massachusetts corporate headquarters.
In fiscal 2020, our former parent began operating a new distribution facility in Columbia, Missouri, which involved shared distribution expenses between our former parent and us. In addition to the portion of our former parent’s corporate expenses allocated to us prior to the Separation, a portion of our former parent’s total distribution expenses was allocated to us. These expense allocations included selling, distribution, inventory management, warehouse, and fulfillment services provided by our former parent and the related benefit costs associated with such functions, such as stock-based compensation and the cost of our former parent’s Columbia, Missouri distribution facility. For the period prior to the Separation in fiscal 2021, we were allocated $2.7 million for such corporate expenses, which were included within general and administrative expenses in our consolidated and combined statements of operations and comprehensive income/(loss). During fiscal 2020, we were allocated $8.7 million for such corporate expenses. For the period prior to the Separation in fiscal 2021, we were also allocated $1.9 million of such distribution expenses, which were included within
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our cost of sales; selling, marketing, and distribution expenses; and general and administrative expenses in the consolidated and combined statements of operations and comprehensive income/(loss). During fiscal 2020, we were allocated $ 8 .2 million of distribution expenses.
Prior to the Separation, costs were allocated to us based on direct usage when identifiable or, when not directly identifiable, on the basis of proportional net sales, employee headcount, delivery units, or square footage, as applicable. We consider the basis on which the expenses have been allocated to reasonably reflect the utilization of services provided to, or the benefit received by, us during the periods presented. However, the allocations may not reflect the expenses we would have incurred if we had been a standalone company for the periods presented prior to the Separation. Actual costs that may have been incurred if we had been a standalone company would depend on a number of factors, including the organizational structure, whether functions were outsourced or performed by employees, and strategic decisions made in areas such as information technology and infrastructure.
Fiscal 2021 Highlights
Our operating results for fiscal 2021 included the following:
•
Net sales were $276.7 million, an increase of $109.3 million, or 65.3%, over the prior fiscal year, reflecting increased net sales in both our e-commerce channels and our traditional channels.
•
Gross margin was 45.8%, an increase of 340 basis points over the prior fiscal year.
•
Net income was $18.4 million, or $1.29 per diluted share, compared with net loss of $96.2 million, or $(6.88) per diluted share, for the prior fiscal year.
•
Non-GAAP Adjusted EBITDAS was $47.3 million, compared with $12.3 million for the prior fiscal year. See non-GAAP financial measure disclosures below for our reconciliation of non-GAAP Adjusted EBITDAS.
•
On August 24, 2020, we entered into a new five-year financing arrangement consisting of a $50.0 million revolving line of credit secured by substantially all the assets of our company with available borrowings determined by a borrowing base calculation. The revolving line includes an option to increase the credit commitment for an additional $15.0 million.
Results of Operations
Net Sales and Gross Profit
The following table sets forth certain information regarding consolidated and combined net sales for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Net sales
$
276,687
$
167,379
$
109,308
65.3
%
Cost of sales
149,859
96,363
53,496
55.5
%
Gross profit
$
126,828
$
71,016
$
55,812
78.6
%
% of net sales (gross margin)
45.8
%
42.4
%
The following table sets forth certain information regarding trade channel net sales for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
e-commerce channels
$
108,726
$
54,316
$
54,410
100.2
%
Traditional channels
167,961
113,063
54,898
48.6
%
Total net sales
$
276,687
$
167,379
$
109,308
65.3
%
Our e-commerce channels include net sales from customers that do not traditionally operate a physical brick-and-mortar store, but generate the majority of their revenue from consumer purchases from their retail websites. Our e-commerce channels also include our direct-to-consumer sales. Our traditional channels include customers that primarily operate out of physical brick-and-mortar stores and generate the large majority of revenue from consumer purchases in their brick-and-mortar locations.
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We sell our products worldwide. The following table sets forth certain information regarding geographic makeup of net sales included in the above table for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Domestic net sales
$
267,573
$
160,905
$
106,668
66.3
%
International net sales
9,114
6,474
2,640
40.8
%
Total net sales
$
276,687
$
167,379
$
109,308
65.3
%
Fiscal 2021 Net Sales Compared with Fiscal 2020
Net sales increased $109.3 million, or 65.3%, over the prior fiscal year, primarily because of higher demand for the majority of our products, which we believe was driven by increased consumer interest in self-protection, indicated by total adjusted background checks as reported to the National Instant Check System, or NICS, that suggests approximately eight million new consumers entered the firearm market in calendar 2020, as well as by increased participation in outdoor activities, such as hunting, camping, and fishing . Our initiative to migrate certain retail customers away from “bulk buy” ordering, which is typically discounted, to a more balanced approach to order replenishment had a favorable impact on net sales and order cadence. In addition, a portion of the increased sales were from strong channel inventory replenishment, new products, and sales to certain strategic retailers that purchased certain slower moving inventory at discounted prices during fiscal 2021. There were also several factors, which we believe were related to the COVID-19 pandemic, such as increased participation in outdoor recreation activities driven by state-mandated travel restrictions, increased retail foot traffic after the reopening of retail locations that were previously ordered to be closed at the end of fiscal 2020, and our ability to replenish retailer inventory after non-essential product orders were halted in our fourth fiscal quarter last year that had a positive impact on our net sales for fiscal 2021. We also believe our investments in our logistics and e-commerce structure have enabled us to respond effectively to increased demand for our products. Net sales in our e-commerce channel increased $54.4 million, or 100.2%, over the prior fiscal year, which we believe resulted from a shift in consumer preference to online purchasers during the current period and increased sales in our own direct-to-consumer business. Net sales in our traditional channels increased $54.9 million, or 48.6%, over the prior fiscal year because of increased consumer interest and the impact of COVID-19 on retail locations after they have reopened, as mentioned above. In addition, feedback from certain of our large retail customers seems to indicate significant growth over the prior fiscal year, reflecting strong consumer demand for our products in the channel. The increase in net sales was partially offset by lower sales to our former parent company and a decline in sales of our branded camping accessory products as a result of an acceleration of one large retail customer’s strategy towards its own private label brand that began in October 2019. Our second fiscal quarter 2021 represented the final quarter in which this comparison occurred.
New products, defined as any new SKU introduced over the prior two fiscal years, represented 35.4% of net sales for fiscal 2021. We have a history of introducing approximately 250 to 350 new SKUs each year, the majority of which are introduced late in our third fiscal quarter.
Our order backlog as of April 30, 2021 was $15.2 million, or $13.4 million higher than at the end of fiscal 2020. The increase in backlog was a result of the timing of our physical inventory count at the end of our fiscal year that reduced the number of shipping days in our fourth quarter, as well as constraints in our supply chain related to port congestion and other factors late in fiscal 2021. Although we generally fulfill the majority of our order backlog, we allow orders received which have not yet shipped to be cancelled, and therefore, our backlog may not be indicative of future sales.
As mentioned above, we believe our fiscal 2021 net sales have increased as a result of several factors related to the COVID-19 pandemic that have resulted in increased participation in outdoor activities, such as hunting, camping, and fishing as well as increased demand driven by increased consumer interest in self-protection. We also believe that increased demand will continue in fiscal 2022. In addition, we anticipate higher inventory and logistics costs in fiscal 2022, which has in turn caused us to increase our prices on our products in fiscal 2022.
Fiscal 2021 Cost of Sales and Gross Profit Compared with Fiscal 2020
Gross margin for fiscal 2021 increased 340 basis points over the prior fiscal year. Gross margins increased 830 basis points primarily because of favorable product mix and lower promotional expenses driven by increased product demand. These increases were partially offset by a 470 basis points decline as a result of writing down a portion of inventory to net realizable value, our sales of slower moving inventory to strategic retailers at a discount that generated lower gross margins, and tariff costs.
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Operating Expenses
The following table sets forth certain information regarding operating expenses for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Research and development
$
5,378
$
4,995
$
383
7.7
%
Selling, marketing, and distribution
56,773
38,596
18,177
47.1
%
General and administrative
41,182
41,292
(110
)
-0.3
%
Impairment of long-lived assets
—
98,929
(98,929
)
-100.0
%
Total operating expenses
$
103,333
$
183,812
$
(80,479
)
-43.8
%
% of net sales
37.3
%
109.8
%
Fiscal 2021 Operating Expenses Compared with Fiscal 2020
Excluding the impact of the goodwill impairment charge in fiscal 2020, operating expenses increased $18.5 million over fiscal 2020. Research and development expenses increased $383,000, primarily as a result of increased compensation-related expenses, employee-related expenses, and consulting expenses over the prior fiscal year. Selling, marketing, and distribution expenses increased $18.2 million, partially as a result of $4.1 million of increased co-op advertising and commission expenses related to certain strategic customers that are generally calculated as a percentage of net sales, $2.4 million of increased costs related to e-commerce advertising, brand awareness initiatives, and website launches; $3.8 million of increased distribution labor costs to increase shipping capacity; and $3.3 million of increased freight expense from increased freight costs and shipments to customers during fiscal 2021. General and administrative expenses decreased $110,000, primarily due to $2.6 million of lower acquired intangible asset amortization, and $1.0 million of facility consolidations, partially offset by higher variable compensation-related expenses.
Operating Income/(Loss)
The following table sets forth certain information regarding operating income/(loss) for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Operating income/(loss)
$
23,495
$
(112,796
)
$
136,291
-120.8
%
% of net sales (operating margin)
8.5
%
-67.4
%
Fiscal 2021 Operating Income/(Loss) Compared with Fiscal 2020
Excluding the impact of the fiscal 2020 goodwill impairment, operating income/(loss) increased $37.4 million over the prior fiscal year . Operating income/(loss) increased primarily because of increased sales volumes and increased gross margin, offset by increased operating expenses as described above.
Interest Income/(Expense), Net
The following table sets forth certain information regarding interest income/(expense), net for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Interest income/(expense), net
$
300
$
4,963
$
(4,663
)
-94.0
%
Interest income/(expense), net decreased $4.7 million from the prior fiscal year because of lower related party notes receivable balances. The related party notes were settled on the date of the Distribution.
Income Taxes
The following table sets forth certain information regarding income tax expense/(benefit) for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Income tax expense/(benefit)
$
5,887
$
(11,653
)
$
17,540
-150.5
%
% of income/(loss) from operations (effective tax rate)
24.2
%
10.8
%
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We recorded an income tax expense of $5.9 million for fiscal 2021 compared with an income tax benefit of $11.7 million for fiscal 2020, primarily because of increased operating profit. The effective tax rates were 24.2% and 10.8% for fiscal 2021 and 2020, respectively. Excluding the impact of the non-cash goodwill impairment charge in fiscal 2020, our effective tax rate for the fiscal year ended April 30, 2020 was 17.4%.
Net Income/(Loss)
The following table sets forth certain information regarding net income/(loss) and the related per share data for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands, except per share data):
2021
2020
$ Change
% Change
Net income/(loss)
$
18,405
$
(96,201
)
$
114,606
-119.1
%
Net income/(loss) per share
Basic
$
1.31
$
(6.88
)
$
8.19
-119.0
%
Diluted
$
1.29
$
(6.88
)
$
8.17
-118.8
%
Fiscal 2021 Net Income/(Loss) Compared with Fiscal 2020
Excluding the impact of goodwill impairment for fiscal 2020, net income increased $15.7 million or $1.09 per diluted share, over the prior fiscal year, primarily because of a combination of favorable product mix and lower promotional expenses driven by increased product demand, favorable manufacturing fixed cost absorption, and lower acquisition related amortization expense .
For periods subsequent to the Separation, the computation of diluted earnings per share excludes the effect of the potential exercise of stock-based awards when the effect of the potential exercise would be anti-dilutive. Our former parent distributed 13,975,104 shares of our common stock, par value $0.001 per share, to its stockholders of record as of the Record Date. We utilize this share amount for the calculation of basic and diluted earnings per share for all periods presented prior to the Separation as all common stock was owned by our former parent prior to the Separation. These shares are treated as issued and outstanding at April 30, 2020 for purposes of calculating historical basic and diluted earnings per share. For periods prior to the Separation, it is assumed that there are no dilutive equity instruments as we had no stock-based awards outstanding prior to the Separation.
Non-GAAP Financial Measure
We use GAAP net income as our primary financial measure. We use Adjusted EBITDAS, which is a non-GAAP financial metric, as a supplemental measure of our performance in order to provide investors with an improved understanding of underlying performance trends, and it should be considered in addition to, but not instead of, the financial statements prepared in accordance with GAAP. Adjusted EBITDAS is defined as GAAP net income/(loss) before interest, taxes, depreciation, amortization, and stock compensation expense. Our Adjusted EBITDAS calculation also excludes certain items we consider non-routine. We believe that Adjusted EBITDAS is useful to understanding our operating results and the ongoing performance of our underlying business, as Adjusted EBITDAS provides information on our ability to meet our capital expenditure and working capital requirements, and is also an indicator of profitability. We believe this reporting provides additional transparency and comparability to our operating results. We believe that the presentation of Adjusted EBITDAS is useful to investors because it is frequently used by analysts, investors, and other interested parties to evaluate companies in our industry. We use Adjusted EBITDAS to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, and to neutralize our capitalization structure to compare our performance against that of other peer companies using similar measures, especially companies that are private. We also use Adjusted EBITDAS to supplement GAAP measures of performance to evaluate our performance in connection with compensation decisions. We believe it is useful to investors and analysts to evaluate this non-GAAP measure on the same basis as we use to evaluate our operating results.
Adjusted EBITDAS is a non-GAAP measure and may not be comparable to similar measures reported by other companies. In addition, non-GAAP measures have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. We address the limitations of non-GAAP measures through the use of various GAAP measures. In the future, we may incur expenses or charges such as those added back to calculate Adjusted EBITDAS. Our presentation of Adjusted EBITDAS should not be construed as an inference that our future results will be unaffected by these items.
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The following table sets forth our calculation of non-GAAP Adjusted EBITDAS for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
Fiscal Year Ended April 30,
2021
2020
GAAP net income/(loss)
$
18,405
$
(96,201
)
Interest expense
111
—
Income tax expense/(benefit)
5,887
(11,653
)
Depreciation and amortization
19,827
23,639
Related party interest income
(424
)
(4,963
)
Stock compensation
2,910
850
Goodwill impairment
—
98,929
Product recall
—
(180
)
Transition costs
264
1,580
COVID-19 costs
223
299
Other
125
—
Non-GAAP Adjusted EBITDAS
$
47,328
$
12,300
Liquidity and Capital Resources
Historically, we have generated strong annual cash flow from operating activities. However, prior to the Separation, we operated within our former parent company’s cash management structure, which used a centralized approach to cash management and financing of operations. Accordingly, a substantial portion of our cash was regularly transferred to our former parent company. This arrangement was not reflective of the manner in which we would have been able to finance our operations had we been an independent, publicly traded company during the periods presented.
The cash and cash equivalents historically held by our former parent company at the corporate level were not specifically identifiable to us and therefore have not been reflected in the historical combined balance sheet. On August 24, 2020, our former parent company capitalized our business with $25.0 million of cash as part of the Separation.
Our former parent company incurred debt and related debt issuance costs with respect to the acquisitions of the carved-out businesses. However, such debt was refinanced since the consummation of these acquisitions, with the proceeds of such refinancing utilized for the retirement of original debt obligations as well as the funding of other former parent company expenditures. As a result, the former parent company third-party long-term debt and the related interest expense was not allocated to us for any of the periods presented as we were not the legal obligor of such debt.
Following the Separation, our capital structure and sources of liquidity changed from the historical capital structure because we no longer participate in our former parent company’s centralized cash management program. Our ability to fund our operating needs depends on our future ability to continue to generate positive cash flow from operations and obtain financing on acceptable terms. Based upon our history of generating strong cash flows, we believe we will be able to meet our short-term liquidity needs. We also believe we will meet known or reasonably likely future cash requirements through the combination of cash flows from operating activities, available cash balances, and available borrowings through our existing $50.0 million credit facility. If these sources of liquidity need to be augmented, additional cash requirements would likely be financed through the issuance of debt or equity securities; however, there can be no assurances that we will be able to obtain additional debt or equity financing on acceptable terms in the future.
Our future capital requirements will depend on many factors, including net sales, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the capital needed to operate as an independent publicly traded company, including the establishment of our independent information technology infrastructure and enterprise resource planning systems, any acquisitions or strategic investments that we may determine to make, and our ability to navigate through the many negative business impacts from the COVID-19 pandemic. Further equity or debt financing may not be available to us on acceptable terms or at all. If sufficient funds are not available or are not available on acceptable terms, our ability to take advantage of unexpected business opportunities or to respond to competitive pressures could be limited or severely constrained.
We had $60.8 million of cash equivalents on hand as of April 30, 2021 and had $234,000 in cash and cash equivalents on hand as of April 30. 2020.
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We expect to utilize our cash flows to continue to invest in our brands, including research and development of new product initiatives, talent and infrastructure , including the implementation of our independent enterprise resource planning systems, which we estimate will cost approximately $8.0 million, and growth strategies, including any potential acquisitions, and to repay any indebtedness we may incur over time.
The following table sets forth certain cash flow information for the fiscal years ended April 30, 2021 and 2020 (dollars in thousands):
2021
2020
$ Change
% Change
Operating activities
$
33,320
$
8,447
$
24,873
294.5
%
Investing activities
(4,181
)
(1,863
)
(2,318
)
124.4
%
Financing activities
31,428
(6,512
)
37,940
-582.6
%
Total cash flow
$
60,567
$
72
$
60,495
84020.8
%
Operating Activities
Operating activities represent the principal source of our cash flow.
Cash generated by operating activities was $33.3 million for fiscal 2021 compared with $8.4 million for the prior fiscal year. Cash generated by operating activities for fiscal 2021 was favorably impacted by $18.4 million of net income as well as $7.9 million of increased payroll, management incentive, and profit sharing accruals, $7.6 million of higher accounts payable due to timing of payments and inventory shipments, and $3.7 million of higher sales volume variable expense accruals, offset by $7.2 million increased accounts receivable due to higher net sales and timing of shipments, and $14.3 million of increased inventory as a result of a planned inventory build in anticipation of new product introductions and to service anticipated increased demand for our products.
Our inventory increased during fiscal 2021, primarily because of a planned inventory build to support the anticipation of new product introductions and additional planned purchases to help mitigate potential future supply chain disruptions. Items impacting our inventory also include increased sales and improved order cadence, which improved inventory turns; increased sales of slow-moving inventory to certain strategic retailers; and a write down of slow moving or excess inventory items to net realizable value. It is possible that worsening of conditions or increased fears of a pandemic could have a renewed and prolonged effect on manufacturing or employment in China, travel to and from China, or other restrictions on imports, all of which could have a longer-term effect on our sales and profitability in future periods. In addition, increased demand for sourced products in various industries could cause delays at various U.S. ports, which could delay the timing of receipt of our products. Therefore, we expect inventory to increase in our first quarter of fiscal 2022 because of a planned inventory build in anticipation of new product introductions combined with our focus on introducing higher priced new products. In addition, we anticipate increased material and logistics costs in fiscal 2022. Based on this, we expect increased inventory values and additional planned purchases to help mitigate potential future supply chain disruptions and price increases.
Investing Activities
Cash used in investing activities was $4.2 million in fiscal 2021 compared with a cash usage of $1.9 million in the prior fiscal year. This increase was mostly due to the fact that we recorded capital expenditures of $3.6 million for fiscal 2021, which was $2.1 million higher than the prior fiscal year. That increase was because of higher expenditures for product tooling and other one-time costs related to the separation of logistics from our former parent company.
Financing Activities
Cash provided by financing activities was $31.4 million in fiscal 2021 compared with a cash usage of $6.5 million in the prior fiscal year. This increase was because of changes in net transfers from our former parent company and the $25.0 million cash capital contribution from our former parent company as part of the Separation.
Credit Facility
On August 24, 2020, we entered into a new five-year financing arrangement in anticipation of the Separation, consisting of a $50 million revolving line of credit secured by substantially all our assets, maturing five years from the start date, with available borrowings determined by a borrowing base calculation. Based on this calculation, the entire $50.0 million was available to us as of April 30, 2021. The revolving line includes an option to increase the credit commitment for an additional $15.0 million. The revolving line bears interest at a fluctuating rate equal to the Base Rate or LIBOR, as applicable, plus the applicable margin. If adequate means
60
do not exist for ascertaining the LIBOR Rate, any borrowing under the credit facility may be converted into Base Rate Loans. The applicable margin can range from a minimum of 0.75% to a maximum of 2.25% based on certain conditions as defined in the credit agreement. The financing arrangement contains covenants relating to minimum debt service coverage. As of April 30 , 2021, we had no borrowings under the revolving line of credit. If we would have had borrowings at April 30 , 2021, those borrowings would have borne interest at approximately 1.93 %, which is equal to the LIBOR rate plus the applicable margin. We recorded $410,000 of debt issuance costs associated with entering into this financing arrangement.
Inflation
We do not believe that inflation had a material impact on us during fiscal 2021 or 2020. However, we have been impacted by changes in prices of finished product inventory from our suppliers and logistics .
We have a strategic sourcing and pricing strategy to mitigate risk from finished product prices from our suppliers and logistics cost fluctuations. We will continue to evaluate the need for future price changes in light of these trends, our competitive landscape, and our financial results. If our sourcing and pricing strategy is unable to offset impacts of the finished product prices from our suppliers and logistics cost fluctuations, our future results from operations and cash flows would be materially impacted.
Critical Accounting Estimates
Revenue Recognition
We recognize revenue for the sale of our products at the point in time when the control of ownership has transferred to the customer, which is generally upon shipment but could be delayed until the receipt of customer acceptance. The revenue recognized for the sale of our products reflect various sales adjustments for discounts, returns, allowances, and other customer incentives. These sales adjustments can vary based on market conditions, customer preferences, timing of customer payments, volume of products sold, and timing of new product launches. These adjustments require us to make reasonable estimates of the amount we expect to receive from the customer. We estimate sales adjustments by customer or by product category on the basis of our historical experience with similar contracts with customers, adjusted as necessary to reflect current facts and circumstances and our expectations for the future.
Valuation of Goodwill and Long-lived Intangible Assets
We test goodwill for impairment on an annual basis on February 1 and between annual tests if indicators of potential impairment exist.
As of our valuation date in fiscal 2021, we had $64.3 million of goodwill. During the annual impairment review process, we have the option to first perform a qualitative assessment, commonly referred to as “step zero”, over relative events and circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value or to perform a quantitative assessment where we estimate the fair value of each reporting unit using both an income and market approach. We completed a step zero assessment as of February 1, 2021, and concluded there were no indicators of impairment.
If the qualitative step zero analysis indicates that its more likely than not that the fair value is less than the carrying value, we will perform a step one analysis. When we perform a step one analysis to assess the recoverability of our goodwill, we determine the estimated fair value of our reporting unit and compare it to the carrying value of the reporting unit, including goodwill. The impairment test compares the fair value of our operating unit to its carrying amounts to assess whether impairment is present. We estimate the fair value of our operating unit using an equal weighting of the fair values derived from the income approach and the market approach because we believe a market participant would equally weight both approaches when valuing the operating unit. The income approach is based on the projected cash flows that are discounted to their present value using discount rates that consider the timing and risk of the forecasted cash flows. Fair value is estimated using internally developed forecasts and assumptions. The discount rate used is the average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. Other significant assumptions include revenue growth rates, profitability projections, and terminal value growth rates. The market approach estimates fair values based on the determination of appropriate publicly traded market comparison companies and market multiples of revenue and earnings derived from those companies with similar operating and investment characteristics as the operating unit being valued. Finally, we compare and reconcile our overall fair value to our market capitalization in order to assess the reasonableness of the calculated fair values of our operating units. We recognize an impairment loss for goodwill if the implied fair value of goodwill is less than the carrying value.
On March 23, 2020, we determined that our business was expected to be negatively impacted by several factors related to the COVID-19 pandemic, including a major online retail customer’s decision to halt or delay most non-essential product
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orders, COVID-19-related supply chain issues, and COVID-19-related “stay at home” orders and sporting goods store closures, which reduced retail foot traffic in many states. Given the extreme market volatility, we relied solely on the income approach to derive the current value of our business. Based on these factors, we expect ed reduced cash flows in our business, and we believe d this constituted a triggering event under generally accepted accounting principles. Based on the results of this evaluation, we recorded an $98.9 million non-cash impairment of goodwill during our fourth quarter of fiscal 2020.
Our assumptions related to the development of fair value could deviate materially from actual results and forecasts used to support asset carrying values may change in the future, which could result in non-cash charges that would adversely affect our results of operations. The re-measurement of goodwill is classified as a Level 3 fair value assessment as described in Note 10 - Fair Value Measurement of the consolidated and combined financial statements , due to the significance of unobservable inputs developed using company-specific information.
We evaluate the recoverability of long-lived intangible assets on an annual basis on February 1 or whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. When such evaluations indicate that the related future undiscounted cash flows are not sufficient to recover the carrying values of the assets, such carrying values are reduced to fair value and this adjusted carrying value becomes the asset’s new cost basis. We determine fair value, primarily using future anticipated cash flows that are directly associated with and are expected to arise as a direct result of the use and eventual disposition of the asset, or asset group, discounted using an interest rate commensurate with the risk involved.
Inventories
We value inventories at the lower of cost, using the first-in, first-out, or FIFO, method, or net realizable value. W e evaluate quantities that make up our current inventory against past and future demand and market conditions to determine excess or slow-moving inventory that may be sold below cost. For each product category, we estimate the market value of the inventory comprising that category based on current and projected selling prices. If the projected market value is less than cost, we will record a provision adjustment to reflect the lower value of the inventory. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold . The projected market value of the inventory may decrease because of consumer preferences or loss of key contracts, among other events.
Recent Accounting Pronouncements
The nature and impact of recent accounting pronouncements is discussed in Note 2 — Summary of Significant Accounting Policies to our consolidated and combined financial statements, which is incorporated herein by reference.
Contractual Obligations and Commercial Commitments
The following table sets forth a summary of our material contractual obligations and commercial commitments as of April 30, 2021 (in thousands):
Less Than
More Than
Total
1 Year
1-3 Years
3-5 Years
5 Years
Operating lease obligations
40,778
3,132
7,094
2,005
28,547
Purchase obligations
83,734
83,734
—
—
—
Total obligations
$
124,512
$
86,866
$
7,094
$
2,005
$
28,547
(1)
Operating lease obligations represent required minimum lease payments during the noncancelable lease term. Most real estate leases also require payments of related operating expenses such as taxes, insurance, utilities, and maintenance, which are not included above. Our operating lease obligations are net of $1.2 million of expected future sublease income.
(2)
Purchase obligations represent binding commitments to purchase raw materials, contract production, and finished products that are payable upon delivery of the inventory. This obligation excludes the amount included in accounts payable at April 30, 2021 related to inventory purchases. Other obligations represent other binding commitments for the expenditure of funds, including (i) amounts related to contracts not involving the purchase of inventories, such as the noncancelable portion of service or maintenance agreements for management information systems, (ii) capital spending, and (iii) advertising.
As of April 30, 2021, we have no borrowings on our revolving line of credit. We are required to make interest payments for the unused portion of our revolving line of credit in accordance with the financing arrangement. Future unused loan fee obligations are not included above, which could accumulate to approximately $160,000 per year, under certain circumstances, until the maturity date in fiscal 2026.
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Off-Balance Sheet Arrangements
We do not have any transactions, arrangements, or other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support or that engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected in our financial statements.