Item 5. Market for Registrant’s Common Equity
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED ST OCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Registrar and Transfer Agent
Computershare Trust Company, N.A.
Correspondence should be mailed to:
Computershare
P.O. Box 43006
Providence, RI 02940-3078
Overnight correspondence should be sent to:
Computershare
150 Royall St.
Canton, MA 02021
(800) 254-5196
(781) 575-2879 (Foreign shareholders)
www.computershare.com/investor
Stock Listing
Culp, Inc. common stock is traded on the New York Stock Exchange (NYSE) under the symbol CULP. As of April 30, 2023, Culp, Inc. had approximately 3,239 shareholders based on the number of holders of record and an estimate of individual participants represented by security position listings.
Analyst Coverage
These analysts cover Culp, Inc.:
Sidoti & Company, LLC – Anthony Lebiedzinski
Water Tower Research – Budd Bugatch, CFA
25
Dividends and Share Repurchases; Sales of Unregistered Securities
Share Repurchases
ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a)
Total
Number
of Shares
Purchased
(b)
Average
Price
Paid per
Share
(c)
Total Number
of Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
(d)
Approximate
Dollar Value
of Shares that
May Yet Be
Purchased
Under
the Plans or
Programs (1)
January 30, 2023 to March 5, 2023
—
$
—
—
$
3,248,094
March 6, 2023 to April 2, 2023
—
$
—
—
$
3,248,094
April 3, 2023 to April 30, 2023
—
$
—
—
$
3,248,094
Total
—
$
—
—
$
3,248,094
(1) In March 2020, our board of directors approved an authorization for us to acquire up to $5.0 million of our common stock.
Dividends
On June 29, 2022, our board of directors announced the decision to suspend the company’s quarterly cash dividend. We believed that preserving capital and managing our liquidity during fiscal 2023 was in the company’s best interest to support future growth and the long-term interests of our shareholders. Accordingly, we did not make any dividend payments during fiscal 2023.
During fiscal 2022, dividend payments totaled $5.5 million, which represented quarterly dividend payments ranging from $0.11 per share to $0.115 per share. During fiscal 2021, dividend payments totaled $5.3 million, which represented quarterly dividend payments ranging from $0.105 per share to $0.11 per share.
Our board of directors has sole authority to determine if and when we will declare future dividends, and on what terms. We will continue to reassess our dividend policy each quarter. Future dividend payments will depend on earnings, capital requirements, financial condition, excess availability under our lines of credit, market and economic conditions, and other factors, including alternative investment opportunities.
Sales of Unregistered Securities
There were no sales of unregistered securities during fiscal 2023, 2022, or 2021.
26
Performance Comparison
The following graph shows changes over the five fiscal years ending April 30, 2023, in the value of $100 invested in (1) the common stock of the company, (2) the Hemscott Textile Manufacturing Group Index reported by Standard and Poor’s, consisting of three companies in the textile industry, and (3) the Standard & Poor’s 500 Index.
The graph assumes an initial investment of $100 at the end of fiscal 2018 and the reinvestment of all dividends during the periods identified.
ITE M 6. [RESERVED]
27
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We have prepared this Management’s Discussion and Analysis as an aid to understanding our financial results. It should be read in conjunction with the consolidated financial statements and notes and other exhibits included elsewhere in this report. It also includes management’s analysis of past financial results and certain potential risk factors that may affect future results, as well as approaches that may be used to manage those risks. See “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report, together with the section of this report titled “Item 1A. RISK FACTORS,” for a discussion of factors that may cause results to differ materially.
General
Our fiscal year is the 52 or 53-week period ending on the Sunday closest to April 30. Fiscal 2023, 2022, and 2021 each included 52- weeks periods.
Our operations are classified into two business segments: mattress fabrics and upholstery fabrics.
Mattress Fabrics
The mattress fabrics segment manufactures, sources, and sells fabrics and mattress covers primarily to bedding manufacturers. Currently, we have mattress fabric operations located in Stokesdale, North Carolina, and Quebec, Canada. During the last half of fiscal 2023, we rationalized our domestic cut and sewn cover platform, which included the termination of agreements to lease two facilities located in High Point, North Carolina, and moving our R&D and prototyping capabilities from these facilities to our facility located in Stokesdale, North Carolina.
Additionally, we acquired the remaining fifty percent ownership interest in our former unconsolidated joint venture located in Ouanaminthe, Haiti, during the fourth quarter of fiscal 2021. As a result, we are now the sole owner with full control of this cut and sewn mattress cover operation (see Note 2 of the consolidated financial statements for further details regarding this business combination).
Upholstery Fabrics
The upholstery fabrics segment develops, sources, manufactures, and sells fabrics primarily to residential and commercial furniture manufacturers. We have upholstery fabric operations located in Shanghai, China, and Burlington, North Carolina. During the third quarter of fiscal 2022, we also commenced operation of a new leased facility in Ouanaminthe, Haiti dedicated to the production of cut and sewn upholstery kits. However, due to a decline in demand for upholstery cut and sewn kits, we terminated the agreement to lease this new facility during the third quarter of fiscal 2023 and relocated a scaled-down upholstery cut and sew operation into our existing mattress cover facility also located in Ouanaminthe, Haiti, during the fourth quarter of fiscal 2023.
Additionally, Read Window Products, LLC, a wholly-owned subsidiary with operations located in Knoxville, Tennessee, provides window treatments and sourcing of upholstery fabrics and other products, as well as measuring and installation services for Read’s products, to customers in the hospitality and commercial industries. Read also supplies soft goods such as decorative top sheets, coverlets, duvet covers, bed skirts, bolsters, and pillows.
Impact of COVID-19
Beginning in the fourth quarter of fiscal 2020, we experienced a significant change in our business resulting from the COVID-19 pandemic. Due to government mandated closure requirements, we shut down our facilities in Canada and Haiti for several weeks, and most of our customers, as well as retail stores in the United States and around the globe, were similarly shut down or operating at significantly reduced capacity. Then in early fiscal 2021, as customer and retail stores began to re-open, we experienced a surge in demand, driven by accelerated demand in the bedding and residential home furnishings industries as consumers shifted their discretionary spending towards home products. Based on this surge, we saw strong growth in our mattress fabrics business and in our residential upholstery fabrics business for the remainder of fiscal 2021 and through much of fiscal 2022. We made several investments during this period that provided expanded capacity to support customers in our mattress fabrics and residential upholstery fabrics businesses. However, beginning in the fourth quarter of fiscal 2022 and continuing throughout fiscal 2023, we experienced a slowdown in demand, driven primarily by weakness in the domestic mattress industry and the residential home furnishings industry as consumer spending trends shifted to travel, leisure, and entertainment, and as inflation pressured consumer spending. This slowdown was exacerbated during much of fiscal 2023 as manufacturers and retailers worked through an excess of inventory, delaying the timing of shipments and new product roll outs. While we believe that our customers' inventory levels began to normalize during the fourth quarter of fiscal 2023, demand in both the mattress industry and the residential home furnishings industry remains soft, and this softness is
28
expected to continue affecting our business for some period. For further information on how COVID-19 has affected and may continue to affect our business and financial condition, see the Risk Factors set forth in Part I, Item 1A of this report.
Executive Summary
We evaluate the operating performance of our business segments based upon (loss) income from operations before certain unallocated corporate expenses and other items that are not expected to occur on a regular basis, such as restructuring expense and restructuring related charges. Cost of sales in each business segment includes costs to develop, manufacture, or source our products, including costs such as raw material and finished good purchases, direct and indirect labor, overhead, and incoming freight charges. Unallocated corporate expenses primarily represent compensation and benefits for certain executive officers and their support staff, all costs associated with being a public company, amortization of intangible assets, and other miscellaneous expenses.
Results of Operations
Twelve Months Ended
(dollars in thousands)
April 30,
2023
May 1,
2022
Change
Net sales
$
234,934
$
294,839
(20.3
)%
Gross profit
10,896
36,093
(69.8
)%
Gross profit margin
4.6
%
12.2
%
(760) bp
Selling, general, and administrative expenses
37,978
35,415
7.2
%
Restructuring expense
1,396
—
100.0
%
(Loss) income from operations
(28,478
)
678
N.M
Operating margin
(12.1
)%
0.2
%
(1230) bp
Loss before income taxes
(28,390
)
(325
)
N.M
Income tax expense
3,130
2,886
8.5
%
Net loss
(31,520
)
(3,211
)
N.M
Net Sales
Our consolidated net sales decreased 20.3% in fiscal 2023 compared with a year ago, with mattress fabric net sales decreasing 27.1% and upholstery fabric net sales decreasing 13.1%.
The decrease in net sales for our mattress fabrics segment during fiscal 2023 primarily reflects a slowdown in consumer demand in the domestic mattress industry. The impact of this industry softness was exacerbated, especially during the first nine months of the fiscal year, by mattress manufacturers and retailers continuing to work through an excess of inventory, delaying the timing of shipments and new product roll outs.
The decrease in upholstery fabrics net sales during fiscal 2023 primarily reflects reduced demand for our residential upholstery fabrics products, driven by a slowdown in new retail business in the residential home furnishings industry, as well as high inventory levels at manufacturers and retailers during the first nine months of the fiscal year. The decrease in net sales was partially offset by higher sales in our hospitality/contract fabric business, as well as receipt of a non-recurring payment relating to newly negotiated terms with a customer of the upholstery segment's Haiti cut and sew platform.
See the Segment Analysis located in the Results of Operations section below for further details.
(Loss) Income Before Income Taxes
Overall, our consolidated loss before income taxes was $(28.4) million for fiscal 2023, compared with loss before income taxes of $(325,000) for the prior year.
Operating performance for fiscal 2023, as compared to the prior year, was primarily pressured by lower sales and operating inefficiencies due to these lower sales; labor challenges within our mattress fabrics business that resulted in increased employee training costs and operating inefficiencies, including quality issues; continued inflationary pressures; operating inefficiencies within the upholstery fabrics segment's cut and sew facility in Haiti due to lower demand; labor challenges and inflationary pressures affecting our Read business; and higher SG&A expense for the year due primarily to higher incentive compensation accrual. It was also affected by (i) $2.9 million in impairment charges during the second quarter due to the write down of inventory to its net realizable value for our mattress fabrics segment; (ii) $2.6 million in losses from closeout sales of raw material and finished goods inventory during the second and third quarter
29
for our mattress fabrics segment; (iii) $2.8 million in markdowns of inventory due to our aged inventory policy for both our mattress fabrics and upholstery fabrics segment; (iv) $713,000 in restructuring and related charges associated with the closure of our upholstery fabric segment's cut and sew facility located in Shanghai, China, during the second quarter; and (v) $781,000 in restructuring charges associated with the rationalization of our upholstery fabrics cut and sew platform located in Ouanaminthe, Haiti, during the third and fourth quarters. Performance for fiscal 2023 was favorably affected by the foreign exchange rate associated with our upholstery fabrics operation in China, as well as receipt of a $1.0 million non-recurring payment during the fourth quarter relating to newly negotiated terms with a customer of the upholstery segment's cut and sew platform in Haiti.
See the Segment Analysis located in the Results of Operations section below for further details.
Income Taxes
We recorded income tax expense of $3.1 million, or (11.0)% of loss before income taxes, for fiscal 2023, compared with income tax expense of $2.9 million, or (888.0)% of loss before income taxes, for fiscal 2022.
Our consolidated effective income tax rate during fiscal 2023 was much more negatively affected by the mix of earnings between our U.S. operations and foreign subsidiaries, as compared with fiscal 2022. During fiscal 2023, we incurred a significantly higher pre-tax loss from our U.S. operations totaling $(33.5) million, compared with $(7.6) million for fiscal 2022. As a result, a significantly higher income tax benefit was not recognized due to a full valuation allowance being applied against our U.S. net deferred income tax assets during fiscal 2023, as compared with fiscal 2022. In addition, almost all of our taxable income during fiscal 2023 and fiscal 2022 was earned by our foreign operations located in China and Canada, which have higher income rates than the U.S.
We also incurred a significantly higher consolidated pre-tax loss totaling $(28.4) million during fiscal 2023, as compared with a much lower consolidated pre-tax loss totaling $(325,000) during fiscal 2022. As a result, the principal differences between income tax expense at the U.S. federal income tax rate compared with the effective income tax rate reflected in the consolidated financial statements were more pronounced in fiscal 2022.
During fiscal 2023 and fiscal 2022, we had income tax payments totaling $2.3 million and $3.1 million, respectively, which mostly represented income tax payments associated with our foreign operations located in China and Canada.
Refer to Note 11 of the consolidated financial statements for further details regarding our provision for income taxes from operations.
Liquidity
As of April 30, 2023, our cash and cash equivalents (“cash") totaled $21.0 million, an increase of $5.4 million, compared with $14.6 million as of May 1, 2022. This increase in cash was mostly due to (i) net cash provided by operating activities totaling $7.8 million and (ii) proceeds totaling $2.1 million from the sale of investments associated with our rabbi trust that sets aside funds for our deferred compensation plan, partially offset by (iii) capital expenditures of $2.1 million and (ii) contributions totaling $1.2 million to our rabbi trust.
Our net cash provided by operating activities was $7.8 million during fiscal 2023, an increase of $25.2 million compared with net cash used in operating activities of $(17.4) million during fiscal 2022. This trend mostly reflects (i) a reduction of inventory related to the significant decline in net sales, improved alignment of inventory purchases with current customer demand trends, and promotional programs to reduce aged raw materials and finished goods inventory; (ii) an abnormally high decrease in accounts payable due to the COVID-19 related shutdowns that affected our operations located in China during the fourth quarter of fiscal 2022, which decrease did not recur in fiscal 2023; (iii) annual incentive payments made during the first quarter of fiscal 2022 that did not recur during fiscal 2023, partially offset by (iv) an abnormally high decrease in accounts receivable due to COVID-19 related shutdowns that affected our operations located in China during the fourth quarter of fiscal 2022, which such decrease did not recur in fiscal 2023, and (v) a decrease in net cash earnings during fiscal 2023 compared with fiscal 2022.
As of April 30, 2023, there were no outstanding borrowings under our lines of credit.
30
Dividend Program
On June 29, 2022, our board of directors announced the decision to suspend the company's quarterly cash dividend. We believed that preserving capital and managing our liquidity during fiscal 2023 was in the company’s best interest to support future growth and the long-term interests of our shareholders. Accordingly, we did not make any dividend payments during fiscal 2023.
During fiscal 2022, dividend payments totaled $5.5 million, which represented quarterly dividend payments ranging from $0.11 share to $0.115.
Our board of directors has sole authority to determine if and when we will declare future dividends, and on what terms. We will continue to reassess our dividend policy each quarter. Future dividend payments will depend on earnings, capital requirements, financial condition, excess availability under our lines of credit, market and economic conditions, and other factors, including alternative investment opportunities.
Common Stock Repurchases
In March 2020, our board of directors approved an authorization for us to acquire up to $5.0 million of our common stock. Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, through plans established under the Securities Exchange Act Rule 10b5-1, or otherwise. The number of shares purchased and the timing of share purchases are based on working capital requirements, market and general business conditions, and other factors, including alternative investment opportunities.
During fiscal 2023, we did not purchase any shares of common stock. As a result, as of April 30, 2023, $3.2 million is available for additional repurchases of our common stock. Despite the current share repurchase authorizations, the company does not expect to repurchase any shares through at least the first quarter of fiscal 2024.
During fiscal 2022, we repurchased 121,688 shares of our common stock at a cost of $1.8 million.
Results of Operations
The following table sets forth certain items in our consolidated statements of net loss as a percentage of net sales.
Fiscal
Fiscal
2023
2022
Net sales
100.0
%
100.0
%
Cost of sales
(95.4
)
(87.8
)
Gross profit
4.6
12.2
Selling, general and administrative expenses
(16.2
)
(12.0
)
Restructuring expense
(0.6
)
—
(Loss) income from operations
(12.1
)
0.2
Interest income
0.2
0.1
Other expense
(0.2
)
(0.5
)
Loss before income taxes
(12.1
)
(0.1
)
Income tax expense *
(11.0
)
(888.0
)
Net loss
(13.4
)
(1.1
)
* Calculated as a percentage of loss before income taxes.
31
2023 compared with 2022
Segment Analysis
Mattress Fabrics Segment
Twelve Months Ended
(dollars in thousands)
April 30,
2023
May 1,
2022
Change
Net sales
$
110,995
$
152,159
(27.1)%
Gross (loss) profit
(6,739
)
16,458
(140.9)%
Gross margin
(6.1
)%
10.8
%
(1690) bp
Selling, general and administrative expenses
11,942
12,246
(2.5)%
(Loss) income from operations
(18,681
)
4,212
N.M.
Operating margin
(16.8
)%
2.8
%
(1960) bp
Net Sales
Mattress fabrics sales decreased 27.1% in fiscal 2023 compared to the prior year. This decrease reflects a material slowdown in consumer demand in the domestic mattress industry throughout the year. We believe this slowdown was primarily due to inflationary pressures affecting consumer spending, as well as a shift in demand from home goods to travel, leisure, and entertainment following a pulling forward of demand for home goods during the early years of the COVID-19 pandemic. The impact of this industry softness was exacerbated, especially during the first nine months of the fiscal year, by mattress manufacturers and retailers working through an excess of inventory, delaying the timing of shipments and new product roll outs. However, we began the roll out of some new customer programs near the end of the third quarter and these roll outs continued during the fourth quarter, driving both year-over-year and sequential improvement for the fourth quarter.
During fiscal 2023, we maintained a continued focus on inventory reductions and cash generation, while executing our product-driven strategy with an ongoing emphasis on innovation, design creativity, and customer relationships. The strength and flexibility of our global manufacturing and sourcing operations in the U.S., Canada, Haiti, Asia, and Turkey also enabled us to support the evolving needs of our mattress fabrics and cover customers throughout the year.
During the second half of the year, we initiated a comprehensive business transformation plan focused on long-term improvement in areas that include quality, sales, marketing, and operational processes; supply chain optimization; employee engagement; and organizational structure. With execution being led by new leadership and a restructured management team, we believe this plan will lay the foundation for steady, sequential improvement in this business. Although the pace of this improvement will be affected by recovery in the overall macroeconomic environment, we believe our market position is growing, and we are optimistic about additional program launches expected during the calendar 2023 year.
Looking ahead, we expect the current macro environment will continue to affect consumer spending trends for some time, resulting in ongoing industry softness that may reduce demand for our mattress fabrics and cover products. We expect these conditions are likely to pressure results through at least the first quarter of fiscal 2024. Additionally, the potential ongoing impacts of Russia’s invasion of Ukraine, as well as impacts from possible additional surges in the coronavirus, remain unknown and depend on factors beyond our knowledge or control. Either of these situations could cause disruption that could adversely affect our operations and financial performance.
Gross Profit and Operating Income
The decrease in mattress fabrics profitability during fiscal 2023, as compared to fiscal 2022, was primarily due to lower sales; operating inefficiencies arising from these lower sales; labor challenges resulting in increased employee training costs and operating inefficiencies, including quality issues; and higher raw material costs. Other factors pressuring the year included $2.9 million in impairment charges during the second quarter due to the write down of inventory to its net realizable value; $2.6 million in losses from closeout sales of raw material and finished goods inventory, and $386,000 in markdowns of inventory based on our policy for aged inventory.
We completed a restructuring and rationalization of our U.S.-based cut and sewn cover platform during the third quarter of fiscal 2023, moving our R&D and prototyping capabilities from our High Point, North Carolina, location to our facility in Stokesdale, North Carolina. The result of this move was the discontinuation of our higher-cost on-shore production capabilities, with closures of our two leased facilities in High Point, North Carolina, during the third quarter. We believe this platform restructuring will allow us to generate cost savings by utilizing our lower-cost mattress cover production and sourcing capabilities in Haiti and Asia, where we can scale operations to align with demand and continue to support the needs of our customers.
32
We expect the ongoing industry softness affecting sales volumes will affect profitability through at least the first quarter of fiscal 2024, although we believe these headwinds will be mitigated to some extent by our ongoing efforts to improve operational efficiencies and control internal costs, as well as our continued roll out of new products priced in line with current costs. We will consider further adjustments to right-size and restructure our operations as necessary to align with current demand levels, as well as additional reasonable pricing actions as competitive conditions permit to further mitigate and manage inflation.
Segment Assets
Segment assets consist of accounts receivable, inventory, property, plant, and equipment, and right of use assets.
(dollars in thousands)
April 30,
2023
May 1,
2022
% Change
Accounts receivable
$
12,396
$
9,865
25.7
%
Inventory
25,674
39,028
(34.2
)%
Property, plant & equipment
33,749
38,731
(12.9
)%
Right of use assets
2,308
3,469
(33.5
)%
Total mattress fabrics segment assets
$
74,127
$
91,093
(18.6
)%
Refer to Note 17 of the consolidated financial statements for disclosures regarding determination of our segment assets.
Accounts Receivable
As of April 30, 2023, accounts receivable increased by $2.5 million, or 25.7%, compared with May 1, 2022. This increase primarily reflects slower cash collections, as we had an unfavorable mix of higher sales volume with customers with longer credit terms during the fourth quarter of fiscal 2023 as compared with the fourth quarter of fiscal 2022. As a result, days' sales outstanding for this segment increased to 37 days for the fourth quarter of fiscal 2023, up from 30 days for the fourth quarter of fiscal 2022. In addition, this increase reflects an increase in net sales during the fourth quarter of fiscal 2023 compared with the fourth quarter of fiscal 2022. Net sales for the fourth quarter of fiscal 2023 were $30.7 million, an increase of 3.1%, compared with th net sales of $29.8 million during the fourth quarter of fiscal 2022.
Inventory
As of April 30, 2023, inventory decreased by $13.4 million, or 34.2%, compared with May 1, 2022. This trend reflects (i) a decline in inventory purchases reflecting the 27.1% decrease in net sales during fiscal 2023 as compared with fiscal 2022, (ii) $3.2 million in non-cash charges recorded during fiscal 2023, which includes $2.9 million related to a write-down of inventory to its net realizable value and $386,000 related to markdowns of inventory estimated based on our policy for aged inventory, (iii) improved alignment of inventory purchases with current customer demand trends, and (iv) promotional programs to reduce aged raw materials and finished goods inventory; partially offset by (v) higher raw material, labor, and overhead costs stemming from inflationary pressures.
Inventory turns were 4.4 for the fourth quarter of fiscal 2023, compared with 2.9 for the fourth quarter of fiscal 2022.
Property, Plant, & Equipment
As of April 30, 2023, property, plant, and equipment decreased by $5.0 million, or 12.9%, compared with May 1, 2022. This decrease represents our concerted effort to reduce capital spending due to current and expected macroeconomic conditions. As a result, depreciation expense totaling $6.1 million exceeded our capital expenditures of $1.1 million during fiscal 2023.
The $33.7 million as of April 30, 2023, represents property, plant, and equipment of $22.7 million, $10.4 million, and $608,000 located in the U.S., Canada, and Haiti, respectively. The $38.7 million as of May 1, 2022, represents property, plant, and equipment of $25.6 million, $12.4 million, and $757,000 located in the U.S., Canada, and Haiti, respectively.
33
Right of Use Assets
As of April 30, 2023, right of use assets decreased by $1.2 million, or 33.5%, compared with May 1, 2022. Right of use assets have steadily decreased due to rent expense incurred over the terms of the respective lease agreements, as well as the termination of two lease agreements related to the closure of our mattress cover operation located in High Point, North Carolina, during fiscal 2023.
The $2.3 million as of April 30, 2023, represents right of use assets of $1.5 million and $766,000 located in Haiti and Canada, respectively. The $3.5 million as of May 1, 2022, represents right of use assets of $2.0 million, $1.2 million, and $291,000 located in Haiti, the U.S., and Canada, respectively.
Upholstery Fabrics Segment
Net Sales
Twelve Months Ended
(dollars in thousands)
April 30,
2023
May 1,
2022
% Change
Non-U.S. Produced
$
114,589
92
%
$
133,271
93
%
(14.0
)%
U.S. Produced
9,350
8
%
9,409
7
%
(0.6
)%
Total
$
123,939
100
%
$
142,680
100
%
(13.1
)%
Upholstery fabrics sales decreased 13.1% in fiscal 2023 compared to the prior year. This decrease reflects reduced demand for our residential upholstery fabric products, driven by a slowdown in new retail business in the residential home furnishings industry, as well as high inventory levels at manufacturers and retailers during the first nine months of the year.
The decrease in net sales for fiscal 2023 was partially offset by higher sales in our hospitality/contract business compared to the prior year, as well as receipt of a $1.0 million non-recurring payment during the fourth quarter relating to newly negotiated terms with a Haiti cut and sew customer.
Looking ahead, we expect the slowdown in new retail business for the residential home furnishings industry may affect demand for our residential business for some period of time. Despite this challenge, we believe our business is well positioned for the long term with our product-driven strategy and innovative product offerings, including our popular portfolio of LiveSmart® performance products, as well as our flexible Asian platform and our long-term supplier relationships.
Notably, the potential ongoing impact of Russia’s invasion of Ukraine, as well as the economic and health effects from possible additional surges in the coronavirus, remain unknown and depend on factors beyond our control. At this time, we cannot reasonably estimate the impact on our upholstery fabrics segment, but we note that if conditions worsen in either of these situations, including additional COVID-related shutdowns of our China operations, the impact on our operations, and/or on our suppliers, customers, consumers, and the global economy, could adversely affect our financial performance.
Gross Profit and Operating Income
Twelve Months Ended
(dollars in thousands)
April 30,
2023
May 1,
2022
Change
Gross profit
$
17,733
$
19,635
(9.7
)%
Gross profit margin
14.3
%
13.8
%
50
bp
Selling, general and administrative expenses
15,739
14,009
12.3
%
Restructuring expense
1,396
—
100.0
%
Income from operations
1,994
5,626
(64.6
)%
Operating margin
1.6
%
3.9
%
(230) bp
The decrease in upholstery fabrics profitability for fiscal 2023, as compared to the prior year, primarily reflects lower residential sales; $2.5 million in markdowns of inventory based on our policy for aged inventory; operating inefficiencies in our cut and sew operation in Haiti due to reduced demand; and labor challenges and inflationary pressures affecting our Read business during the year. These pressures were partially offset by a significantly more favorable foreign exchange rate associated with our operations in China; receipt of a $1.0 million non-recurring payment during the fourth quarter relating to newly negotiated terms with a customer of our Haiti cut
34
and sew platform; and lower overhead costs resulting from the restructuring of our cut and sew platforms in China and Haiti during fiscal 2023, as described in more detail below.
Based on market dynamics for cut and sewn products and the strength of our Asian supply chain, we took action during the second quarter of fiscal 2023 to restructure and adjust our model for this platform with the closure of our cut and sew facility located in Shanghai, China. We believe this move will allow us to reduce our operating costs while maintaining our ability to support our customers, grow our cut and sew business, and maintain our competitive advantages through our lower-cost manufacturing and sourcing operations in Asia and Haiti.
We also took action during the third quarter of fiscal 2023 to rationalize and consolidate our cut and sew upholstery kit platform in Haiti, based on ongoing demand weakness for cut and sewn products. This restructuring better aligns our capacity and costs with current demand levels for upholstery kits. We believe this move, which included terminating a lease and relocating a scaled-down operation into an existing facility for our mattress cover business, will allow us to reduce our operating costs without sacrificing our ability to support our customers.
Looking ahead, the residential home furnishings industry remains under pressure due to shifting consumer spending trends and inflation affecting overall consumer spending. As a result, we expect lower sales volumes in our residential business will continue to affect our profitability. However, for fiscal 2024, we expect to benefit from a rationalized Haiti operation, improved inventory management, a solid hospitality/contract fabric business, and improvement in our Read business. We will also continue our ongoing cost reduction efforts and will consider further adjustments to right-size and restructure our operations as necessary to align with current demand levels, while maintaining our ability to service our customers.
Restructuring Activities
Second Quarter of Fiscal 2023 - China
During the second quarter of fiscal 2023, we closed our cut and sew upholstery fabrics operation located in Shanghai, China, which included the termination of an agreement to lease a building. This strategic action, along with the further use of our Asian supply chain, was our response to declining consumer demand for cut and sewn products, by adjusting our operating costs to better align with the lower demand. As a result of this strategic action, we recorded restructuring expense and restructuring related charges totaling $713,000. These charges represent employee termination benefits of $468,000, loss from the disposal and markdowns of inventory of $98,000, impairment loss associated with equipment of $80,000, lease termination costs of $47,000, and other associated costs of $20,000. Of the total $713,000, $615,000 and $98,000 were recorded to restructuring expense and cost of sales, respectively, in the fiscal 2023 Consolidated Statement of Net Loss.
Third and Fourth Quarters of Fiscal 2023 - Haiti
Effective January 24, 2023, we entered into an agreement to terminate a lease ("the Termination Agreement") of a facility (the "Terminated Facility") located in Ouanaminthe, Haiti, that was used solely for the production of cut and sewn kits associated with our upholstery fabrics segment. As a result, we relocated production of cut and sewn upholstery kits into another existing facility that is also located in Ouanaminthe, Haiti, and leased by an affiliate that produces mattress covers at this facility. As a result, we will produce both upholstery cut and sewn kits and mattress covers in this location. We believe this strategic action will realign our capacity and costs with current demand levels, while still allowing us to support our customers and scale for additional capacity if conditions improve.
Based on the terms of the Termination Agreement, we vacated and returned possession of the Terminated Facility to the lessor, and a third party lessee took possession of the Terminated Facility and agreed to pay us $2.4 million over a period commencing April 1, 2023, through December 31, 2029, for the right to use the Terminated Facility. The terms of the Termination Agreement fully and unconditionally released and discharged us from all of our remaining obligations under the original lease for the Terminated Facility.
As a result of this strategic action, we recorded restructuring expense of $781,000 during the third and fourth quarters of fiscal 2023, which represents lease termination costs of $434,000, an impairment loss regarding leasehold improvements totaling $277,000, employee termination benefits of $39,000, and other associated costs of $31,000.
The following summarizes our restructuring expense and restructuring related charges that were associated with both of our restructuring activities noted above for fiscal 2023:
35
(dollars in thousands)
2023
Employee termination benefits
$
507
Lease termination costs
481
Impairment loss - leasehold improvements and equipment
357
Loss on disposal and markdowns of inventory
98
Other associated costs
51
Restructuring expense and restructuring related charges (1)
$
1,494
(1) Of the total $1.5 million, $1.4 million and $98,000 were recorded to restructuring expense and cost of sales, respectively, in the fiscal 2023 Consolidated Statement of Net Loss.
Segment Assets
Segment assets consist of accounts receivable, inventory, property, plant, and equipment, and right of use assets.
(dollars in thousands)
April 30,
2023
May 1,
2022
% Change
Accounts receivable
$
12,382
$
12,361
0.2
%
Inventory
19,406
27,529
(29.5
)%
Property, plant & equipment
1,671
2,030
(17.7
)%
Right of use assets
2,618
8,124
(67.8
)%
Total upholstery fabrics segment assets
$
36,077
$
50,044
(27.9
)%
Accounts Receivable
As of April 30, 2023, accounts receivable remained flat compared with May 1, 2022. This trend reflects faster cash collections as we had a favorable mix of higher sales volume with customers with shorter credit terms during the fourth quarter of fiscal 2023 compared with the fourth quarter of fiscal 2022. As a result, days' sales outstanding for this segment decreased to 33 days for the fourth quarter of fiscal 2023, down from 40 days for the fourth quarter of fiscal 2022. The faster cash collections that occurred during the fourth quarter of fiscal 2023 were partially offset by an increase in net sales during the fourth quarter of fiscal 2023, as compared with the fourth quarter of fiscal 2022. Net sales for the fourth quarter of fiscal 2023 were $30.7 million, an increase of of $3.6 million, or 13.1%, compared with net sales of $27.2 million during the fourth quarter of fiscal 2022.
Inventory
As of April 30, 2023, inventory decreased by $8.1 million, or 29.5%, compared with May 1, 2022. This trend reflects (i) a decline in inventory purchases reflecting the 13.1% decrease in net sales during fiscal 2023 compared with fiscal 2022, (ii) a $2.6 million non-cash charge recorded during fiscal 2023, which includes $2.5 million of markdowns of inventory estimated based on our policy for aged inventory and $98,000 that was associated with the loss on disposal and markdowns of inventory related to the exit from our cut and sew upholstery fabrics operation located in Shanghai, China, (iii) improved alignment of inventory purchases with current customer demand trends, and (iv) promotional programs to reduce aged raw materials and finished goods inventory; partially offset by (v) higher raw material, labor, and overhead costs stemming from inflationary pressures.
Inventory turns were 4.8 during the fourth quarter of fiscal 2023, compared with 3.0 for the fourth quarter of fiscal 2022.
Property, Plant, & Equipment
As of April 30, 2023, property, plant, and equipment decreased by $359,000, or 17.7%, compared with May 1, 2022. This decrease represents our concerted effort to reduce capital spending due to current and expected macroeconomic conditions. As a result, depreciation expense totaling $795,000 exceeded our capital expenditures of $467,000 during fiscal 2023.
The $1.7 million as of April 30, 2023, represents property, plant, and equipment of $974,000, $592,000, and $105,000 located in the U.S., Haiti, and China, respectively. The $2.0 million as of May 1, 2022, represents property, plant, and equipment of $1.0 million, $756,000, and $255,000 located in the U.S., Haiti, and China, respectively.
Right of Use Assets
As of April 30, 2023, our right of use assets decreased by $5.5 million, or 67.8%, compared with May 1, 2022. This decrease mostly resulted from (i) six-month forgiveness of rent payments associated with COVID-19 relief permitted by the Chinese government for all building lease agreements located in Shanghai, China, (ii) the termination of a building lease agreement in connection with the exit from
36
our cut and sew operation located in Shanghai, China, and (iii) the termination of a building lease agreement in connection with the rationalization of our cut and sew upholstery fabrics operation located in Ouanaminthe, Haiti.
The $2.6 million as of April 30, 2023, represents right of use assets of $1.5 million and $1.1 million located in China and the U.S., respectively. The $8.1 million as of May 1, 2022, represents right of use assets of $3.7 million, $2.6 million, and $1.8 million located in China, Haiti, and the U.S., respectively.
Other Income Statement Categories
Twelve Months Ended
(dollars in thousands)
April 30,
2023
May 1,
2022
% Change
Selling, general, and administrative expenses
$
37,978
$
35,415
7.2
%
Interest expense
—
17
(100.0
)%
Interest income
531
373
42.4
%
Other expense
443
1,359
(67.4
)%
Selling, General, and Administrative Expenses
The increase in selling, general, and administrative expenses during fiscal 2023, as compared with fiscal 2022, is mostly due to higher incentive compensation expense that relates to our annual bonuses, reflecting the achievement of favorable financial results in relation to pre-established free cash flow performance targets pertaining solely to the upholstery fabrics segment and the executive shared services reporting unit.
Interest Expense
Interest expense reflects our historically low level and short duration of borrowings outstanding.
Interest Income
The increase in interest income is due primarily to higher market interest rates earned during fiscal 2023, compared with fiscal 2022.
Other Expense
Management is required to assess certain economic factors to determine the currency of the primary economic environment in which our foreign subsidiaries operate. Based on our assessments, the U.S. dollar was determined to be the functional currency of our operations located in China and Canada.
Other expense during fiscal 2023 decreased $916,000, or 67.4%, compared with fiscal 2022. This decrease primarily relates to more favorable foreign currency exchange rates applied against our balance sheet accounts denominated in Chinese Renminbi to determine the corresponding U.S. dollar financial reporting amounts. During fiscal 2023, we reported a foreign exchange rate gain of $588,000 associated with our operations located in China, compared with a foreign exchange rate loss of $(104,000) incurred during fiscal 2022. In addition, we incurred a realized loss totaling $450,000 on the sale of our remaining short-term available-for-sale and held-to-maturity investments that mostly occurred during the fourth quarter of fiscal 2022, which realized loss did not recur during fiscal 2023.
The $588,000 foreign exchange rate gain related to our operations located in China was mostly non-cash, and was mostly offset by $355,000 of income tax expense, which will increase our income tax payments and withholding tax payments associated with future earnings and profits repatriated from our operations located in China to the company's U.S. parent. This income tax expense of $355,000 was associated with taxable foreign exchange rate gains based on less favorable foreign currency exchange rates applied against balance sheet accounts denominated in U.S. dollars to determine the corresponding Chinese Renminbi local currency amounts. The foreign exchange rate gains incurred on our U.S. dollar denominated balance sheet accounts associated with our operations located in China are considered taxable income, as we incur income tax expense and pay income taxes in China’s local currency.
Income Taxes
Effective Income Tax Rate & Income Tax Expense
We recorded income tax expense of $3.1 million, or (11.0)% of loss before income taxes, during fiscal 2023, compared with income tax expense of $2.9 million, or (888.0)% of loss before income taxes, during fiscal 2022.
37
The following schedule summarizes the principal differences between income tax expense at the federal income tax rate and the effective income tax rate reflected in the consolidated financial statements:
2023
2022
U.S. federal income tax rate
21.0
%
21.0
%
valuation allowance
(24.0
)
(56.3
)
global intangible low taxed income tax (GILTI)
—
(540.9
)
foreign tax rate differential
(4.0
)
(206.2
)
income tax effects of Chinese foreign exchange gains and losses
(0.9
)
(20.6
)
withholding taxes associated with foreign tax jurisdictions
(2.4
)
(172.8
)
uncertain income tax positions
(0.3
)
105.4
U.S. state income taxes
0.6
21.5
stock-based compensation
(0.3
)
(3.3
)
other (3)
(0.7
)
(35.8
)
consolidated effective income tax rate (1) (2)
(11.0
)%
(888.0
)%
(1) Our consolidated effective income tax rate during fiscal 2023 was much more negatively affected by the mix of earnings and losses between our U.S. operations and foreign subsidiaries, as compared with fiscal 2022. During fiscal 2023, we incurred a significantly higher pre-tax loss from our U.S. operations totaling $(33.5) million, compared with $(7.6) million for fiscal 2022. As a result, a significantly higher income tax benefit was not recognized due to a full valuation allowance being applied against our U.S. net deferred income tax assets during fiscal 2023, as compared with fiscal 2022. In addition, almost all of our taxable income for each of fiscal 2023 and 2022 was earned by our foreign operations located in China and Canada, which have higher income tax rates than the U.S.
(2) During fiscal 2023, we incurred a significantly higher consolidated pre-tax loss totaling $(28.4) million, compared with a much lower consolidated pre-tax loss totaling $(325,000) during fiscal 2022. As a result, the principal differences between income tax expense at the U.S. federal income tax rate and the effective income tax rate reflected in the consolidated financial statements were more pronounced for fiscal 2022, as compared with fiscal 2023.
(3) “Other” for all periods presented represents miscellaneous adjustments that pertain to U.S. permanent differences such as meals and entertainment and income tax provision to return adjustments.
GILTI
Fiscal 2022
Effective July 20, 2020, the U.S. Treasury Department finalized and enacted previously proposed regulations regarding the GILTI tax provisions of the Tax Cuts and Jobs Act of 2017 (“TCJA”). With the enactment of these final regulations, we became eligible for an exclusion from GILTI if we meet the provisions of the GILTI High-Tax exception included in these final regulations on a jurisdiction-by-jurisdiction basis. To meet the provisions of the GILTI High-Tax exception, the tested foreign entity’s effective income tax rate related to current year’s earnings must be higher than 90% of the U.S. Federal income tax rate of 21% (i.e.,18.9%).
We did not meet the GILTI High-Tax exception for the 2021 tax year regarding our operations located in China. This was due primarily to significant income tax deductible foreign exchange losses that significantly lowered income tax expense associated with current year’s earnings. As a result, the current effective income tax rate was lower than the required 18.9% current effective income tax rate to meet the GILTI High-Tax exception. Consequently, we incurred a non-cash income tax charge of $1.8 million, which charge was fully offset by a $1.8 million non-cash income tax benefit due to a corresponding reversal of our full valuation allowance associated with our U.S. net deferred income tax assets.
We did not meet the GILTI High-Tax exception for the 2022 tax year regarding our foreign operations located in Canada and Haiti. With regard to Canada, we placed several significant capital projects into service during fiscal 2022, and therefore, were eligible for a significant amount of income tax deductible accelerated depreciation. As a result, our current year’s income tax expense was much lower than prior years, and therefore, our current effective income tax rate was lower than the required 18.9% current effective income tax rate to meet the GILTI High-Tax exception. For our operations in Haiti, taxable income or losses are not subject to income tax, as we are located in an economic zone that permits a 0% income tax rate for the first fifteen years of operations, for which we have nine years remaining. Since our operations located in Haiti are not subject to income tax, our current effective income tax rate was 0%, which is lower than the required 18.9% current effective income tax rate to meet the GILTI High-Tax exception. Although our operations located in Canada and Haiti did not meet the GILTI High-Tax exception, we incurred a nominal amount of GILTI tax for the 2022 tax
38
year, as the losses subject to GILTI tax from our Haitian operations mostly offset the income subject to GILTI tax from our Canadian operation.
Fiscal 2023
We do not expect to pay GILTI tax for the 2023 tax year, as we expect to meet the GILTI High-Tax exception regarding our operations located in China and Canada, and we incurred taxable losses associated with our operations located in Haiti.
Deferred Income Taxes – Valuation Allowance
We evaluate the realizability of our deferred income taxes to determine if a valuation allowance is required. We assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more-likely-than-not” standard, with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, considering the effects of local tax law.
As of April 30, 2023, we evaluated the realizability of our U.S. net deferred income tax assets to determine if a full valuation allowance was still required. Based on our assessment, we determined we still have a recent history of significant cumulative U.S. pre-tax losses, in that we experienced U.S. pre-tax losses during each of the last three fiscal years. In addition, we are currently expecting U.S. pre-tax losses to continue into fiscal 2024. As a result of the significant weight of this negative evidence, we believe it is more-likely-than-not that our U.S. net deferred income tax assets will not be fully realizable, and therefore we provided for a full valuation allowance against our U.S. net deferred income tax assets totaling $18.7 million as of April 30, 2023.
Refer to Note 11 of the consolidated financial statements for additional disclosures regarding the valuation allowance against our U.S. net deferred income taxes.
Deferred Income Taxes – Undistributed Earnings from Foreign Subsidiaries
We assess whether the undistributed earnings from our foreign subsidiaries will be reinvested indefinitely or eventually distributed to our U.S. parent company, and whether we are required to a record a deferred income tax liability for those undistributed earnings from foreign subsidiaries that will not be reinvested indefinitely. As of April 30, 2023, we assessed the liquidity requirements of our U.S. parent company and determined that our undistributed earnings from our foreign subsidiaries would not be reinvested indefinitely and therefore, would be eventually distributed to our U.S. parent company. The conclusion reached from our assessment is consistent with prior years. Accordingly, as of April 30, 2023, we recorded a deferred income tax liability associated with our undistributed earnings from foreign subsidiaries of $4.2 million.
Refer to Note 11 of the consolidated financial statements for additional disclosures regarding our deferred income tax liability associated with the undistributed earnings from our foreign subsidiaries.
Uncertainty in Income Taxes
An unrecognized income tax benefit for an uncertain income tax position can be recognized in the first interim period if the more-likely-than-not recognition threshold is met by the end of the reporting period, or if the position is effectively settled through examination, negotiation, or litigation, or if the statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired. If it is determined that any of the above conditions occur regarding our uncertain income tax positions, an adjustment to our unrecognized income tax benefit will be recorded at that time.
As of April 30, 2023, we had a $1.2 million total gross unrecognized income tax benefit that primarily relates to double taxation under applicable income tax treaties with foreign tax jurisdictions. At this time, significant change associated with this income tax benefit is not expected within the next fiscal year.
U.S. federal and state income tax returns filed by us remain subject to examination for income tax years 2019 and subsequent. Canadian federal income tax returns filed by us remain subject to examination for income tax years 2019 and subsequent. Canadian provincial (Quebec) income tax returns filed by us remain subject to examination for income tax years 2019 and subsequent. Income tax returns associated with our operations located in China are subject to examination for income tax year 2018 and subsequent.
Refer to Note 11 of the consolidated financial statements for disclosures and additional information regarding our uncertain income tax positions.
39
Income Taxes Paid
The following table sets forth income taxes paid by jurisdiction:
(dollars in thousands)
2023
2022
United States Federal - Transition Tax
265
266
China - Income Taxes
1,831
2,036
China - Withholding Taxes Associated with Earnings
and Profits Distribution to U.S. Parent
—
487
Canada - Income Taxes
228
311
$
2,324
$
3,100
Future Liquidity
We are currently projecting annual cash income tax payments of approximately $2.5 million for fiscal 2024, compared with $2.3 million and $3.1 million for fiscal 2023 and fiscal 2022, respectively. Our estimated cash income tax payments for fiscal 2024 are management’s current projections only and can be affected by actual earnings from our foreign subsidiaries located in China and Canada versus annual projections; changes in the foreign exchange rates associated with our operations located in China in relation to the U.S. dollar; the timing of when we will repatriate earnings and profits from China; and the timing of when significant capital projects will be placed into service, which determines the deductibility of accelerated depreciation.
Additionally, we currently do not expect to incur any income taxes in the U.S. on a cash basis during fiscal 2024 due to (i) the immediate expensing of U.S. capital expenditures, and (ii) our existing U.S. federal net operating loss carryforwards. In accordance with the TCJA, we will be required to pay annual U.S. federal transition tax payments as follows: FY 2024 - $499,000; FY 2025- $665,000; and FY 2026 - $831,000.
2022 compared with 2021
For a comparison of our results of operations for the fiscal years ended May 1, 2022, and May 2, 2021, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended May 1, 2022, filed with the SEC on July 15, 2022.
Liquidity and Capital Resources
Overall
Currently, our sources of liquidity include cash and cash equivalents ("cash"), cash flow from operations, and amounts available under our revolving credit lines. As of April 30, 2023, we believe our cash of $21.0 million, cash flow from operations, and the current availability under our revolving credit lines totaling $32.6 million (Refer to Note 10 of the consolidated financial statements for further details) will be sufficient to fund our foreseeable business needs, capital expenditures, commitments, and contractual obligations.
As of April 30, 2023, our cash totaled $21.0 million, an increase of $5.4 million compared with $14.6 million as of May 1, 2022. The increase in cash was mostly due to (i) net cash provided by operating activities totaling $7.8 million and (ii) proceeds totaling $2.1 million from the sale of investments associated with our rabbi trust that sets aside funds for our deferred compensation plan, partially offset by (iii) capital expenditures of $2.1 million and (iv) contributions totaling $1.2 million to our rabbi trust.
Our net cash provided by operating activities was $7.8 million during fiscal 2023, an increase of $25.2 million compared with net cash used in operating activities of $(17.4) million during fiscal 2022. This trend mostly reflects (i) a reduction of inventory related to the significant decline in net sales, improved alignment of inventory purchases with current customer demand trends, and promotional programs to reduce aged raw materials and finished goods inventory; (ii) an abnormally high decrease in accounts payable due to the COVID-19 related shutdowns that affected our operations located in China during the fourth quarter of fiscal 2022, which decrease did not recur during fiscal 2023; (iii) annual incentive payments made during the first quarter of fiscal 2022 that did not recur during fiscal 2023, partially offset by (iv) an abnormally high decrease in accounts receivable due to COVID-19 related shutdowns that affected our operations located in China during the fourth quarter of fiscal 2022, which decrease did not recur during fiscal 2023, and (v) a decrease in net cash earnings during fiscal 2023 compared with fiscal 2022.
As of April 30, 2023, there were no outstanding borrowings under our lines of credit.
40
The income taxes we pay also affect our liquidity. See the above section titled “ Income Taxes Paid ” of this Item 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION for further details.
Our cash may be adversely affected by factors beyond our control, such as (i) customer demand trends, (ii) supply chain disruptions, (iii) rising interest rates and inflation, (iv) world events (including the Russian-Ukraine war), and (v) the continuing uncertainty associated with COVID-19. These factors could cause delays in receipt of payment on accounts receivable and could increase cash disbursements due to rising prices.
By Geographic Area
A summary of our cash by geographic area follows:
April 30,
May 1,
(dollars in thousands)
2023
2022
United States
$
9,769
$
4,430
China
10,669
9,502
Canada
281
267
Haiti
236
341
Cayman Islands
9
10
$
20,964
$
14,550
Dividend Program
On June 29, 2022, our board of directors announced the decision to suspend the company's quarterly cash dividend. We believed that preserving capital and managing our liquidity during fiscal 2023 was in the company’s best interest to support future growth and the long-term interests of our shareholders. Accordingly, we did not make any dividend payments during fiscal 2023.
During fiscal 2022, dividend payments totaled $5.5 million, which represented quarterly dividend payments ranging from $0.11 share to $0.115.
Our board of directors has sole authority to determine if and when we will declare future dividends, and on what terms. We will continue to reassess our dividend policy each quarter. Future dividend payments will depend on earnings, capital requirements, financial condition, excess availability under our lines of credit, market and economic conditions, and other factors, including alternative investment opportunities.
Common Stock Repurchases
In March 2020, our board of directors approved an authorization for us to acquire up to $5.0 million of our common stock. Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, through plans established under the Securities Exchange Act Rule 10b5-1, or otherwise. The number of shares purchased and the timing of share purchases are based on working capital requirements, market and general business conditions, and other factors, including alternative investment opportunities.
During fiscal 2023, we did not purchase any shares of common stock. As a result, as of April 30, 2023, $3.2 million is available for additional repurchases of our common stock. Despite the current share repurchase authorizations, the company does not expect to repurchase any shares through at least the first quarter of fiscal 2024.
During fiscal 2022, we repurchased 121,688 shares of our common stock at a cost of $1.8 million.
Working Capital
Operating Working Capital
Operating working capital (accounts receivable and inventories, less deferred revenue, accounts payable-trade, and accounts payable-capital expenditures) was $39.2 million as of April 30, 2023, compared with $67.7 million as of May 1, 2022. Operating working capital turnover was 4.6 during the fourth quarter of fiscal 2023 compared with 5.2 during the fourth quarter fiscal 2022. The decrease in working capital was mostly due to the significant decrease in inventory during fiscal 2023 compared with fiscal 2022, as described in the Inventory section below.
41
Accounts Receivable
Accounts receivable as of April 30, 2023, were $24.8 million, an increase of $2.6 million, or 11.5%, compared with $22.2 million as of May 1, 2022. This trend reflects an increase in net sales during the fourth quarter of fiscal 2023 compared with the fourth quarter of fiscal 2022. Net sales for the fourth quarter of fiscal 2023 were $61.4 million, an increase of $4.5 million, or 7.9%, compared with net sales of $56.9 million during the fourth quarter of fiscal 2022. The increase in net sales for the fourth quarter of fiscal 2023 compared with fiscal 2022 is primarily due to the COVID-19 related shutdowns that affected our operations located in China during the fourth quarter of fiscal 2022, which shutdowns did not recur during the fourth quarter of fiscal 2023.
Days’ sales outstanding were 35 days for the fourth quarter of fiscal 2023 and 2022, respectively.
Inventory
Inventories as of April 30, 2023, were $45.1 million, a decrease of $21.5 million, or 32.3%, compared with $66.6 million as of May 1, 2022. This trend reflects (i) a decline in inventory purchases reflecting a 20.3% decrease in net sales during fiscal 2023 compared with fiscal 2022; (ii) a $5.8 million non-cash inventory charge recorded during fiscal 2023, which includes a $2.9 million impairment charge associated with our mattress fabrics segment, $2.8 million of markdowns of inventory estimated based on our policy for aged inventory, and $98,000 that was associated with the loss on disposal and markdowns of inventory related to the exit from our cut and sew upholstery fabrics operation located in Shanghai, China; (iii) improved alignment of inventory purchases with current customer demand trends; and (iv) promotional programs to reduce aged raw materials and finished goods inventory, partially offset by (v) higher raw material, labor, and overhead costs stemming from inflationary pressures.
Inventory turns were 4.7 for the fourth quarter of fiscal 2023, compared with 3.1 for the fourth quarter of fiscal 2022.
Accounts Payable
Accounts payable - trade were $29.4 million as of April 30, 2023, an increase of $9.3 million, or 46.5%, compared with $20.1 million as of May 1, 2022. This increase in accounts payable - trade is primarily due to the COVID-19 related shutdowns that affected our operations located in China during the fourth quarter of fiscal 2022, which shutdowns did not recur during the fourth quarter of fiscal 2023.
Financing Arrangements, Commitments and Contingencies, and Contractual Obligations
Revolving Credit Agreements
Currently, we have revolving credit agreements with banks for our U.S. parent company and our operations located in China.
As of April 30, 2023, we did not have any outstanding borrowings associated with our revolving credit agreements.
Our loan agreements require, among other things, that we maintain compliance with certain financial covenants. As of April 30, 2023, we were in compliance with these financial covenants.
Refer to Note 10 of the consolidated financial statements for further disclosure regarding our revolving credit agreements.
Leases
Refer to Note 12 of the consolidated financial statements for disclosure of our lease obligations, which includes a five-year maturity schedule.
Capital Expenditures
As of April 30, 2023, and May 1, 2022, we had total amounts due regarding capital expenditures totaling $56,000 and $473,000, respectively, which pertained to outstanding vendor invoices, none of which were financed.
Uncertain Income Tax Positions
As of April 30, 2023, we had $1.2 million of total gross unrecognized tax benefits, which primarily relate to double taxation under applicable income tax treaties with foreign tax jurisdictions. The outcome of these income tax uncertainties is dependent upon various matters including tax examinations, legal proceedings, competent authority proceedings, changes in regulatory tax laws, or interpretations of those tax laws, or expiration of statutes of limitation. As a result of these inherent uncertainties, we cannot reasonably estimate the timing of payment on this amount, if any.
42
Capital Expenditures and Depreciation Expense
Capital expenditures on a cash basis were $2.1 million during fiscal 2023, compared with $5.7 million during fiscal 2022. Capital spending during fiscal 2023 primarily related to our mattress fabrics segment, and decreased compared with fiscal 2022 as a result of our concerted effort to conserve cash and reduce capital spending due to current and expected macroeconomic conditions.
Depreciation expense was $6.8 million during fiscal 2023, compared with $7.0 million during fiscal 2022. Depreciation expense for fiscal 2023 and fiscal 2022 mostly related to our mattress fabrics segment.
For fiscal 2024, cash capital expenditures are still expected to focus primarily on maintenance level capital spending centered on our mattress fabrics segment, but are expected to increase modestly as compared to fiscal 2023. Funding for capital expenditures is expected to be primarily from cash provided by operating activities.
Handling Costs
We record warehousing costs in SG&A expenses. These costs were $4.2 million during fiscal 2023 and $4.3 million during fiscal 2022. Warehousing costs include the operating expenses of our various finished goods distribution centers, such as personnel costs, utilities, building rent and material handling equipment, and lease expense. Had these costs been included in cost of sales, gross profit would have been $6.7 million, or 2.8% of net sales, during fiscal 2023, and $31.8 million, or 10.8% of net sales, during fiscal 2022.
Inflation
Any significant increase in our raw material costs, utility/energy costs, and general economic inflation could have a material adverse impact on the company, because competitive conditions have limited our ability to pass significant operating increases on to customers.
Near the end of fiscal 2021, our raw material costs began to escalate primarily due to rising oil prices, a higher demand environment, and labor shortages. These pressures continued during fiscal 2022, with further increases in raw material costs, particularly during the second half of the year. While the cost of raw materials began to decline during the first half of fiscal 2023 year due to lower oil prices and slowing global demand, the higher costs and lower availability of labor remained challenging throughout the year.
Inflationary pressures also affected consumer spending during the second half of fiscal 2022 and continuing throughout fiscal 2023, causing a slowdown in business in the mattress industry and residential home furnishings industry. This slowdown caused reduced demand for our mattress and residential upholstery fabrics products during this period.
Critical Accounting Estimates
U.S. generally accepted accounting principles require us to make estimates and assumptions that affect our reported amounts in the consolidated financial statements and accompanying notes. Our estimates are based on (i) currently known facts and circumstances, (ii) prior experience, (iii) assessments of probability, (iv) forecasted financial information, and (v) assumptions that management believes to be reasonable but that are inherently uncertain and unpredictable. We use our best judgment when measuring these estimates, and if warranted, use external advice. Due to the uncertain and unpredictable nature of our estimates, actual results could differ from the estimates that were previously reported in our consolidated financial statements.
As of April 30, 2023, we believe the following list represents our critical accounting estimates that have or are reasonably likely to have a material effect on our financial condition or results of operations. For a discussion of all our significant accounting policies, including our critical accounting policies, refer to Note 1 of the consolidated financial statements.
Inventory Valuation
We operate as a “make-to-order” and “make-to-stock” business. Although management closely monitors demand for each product category to decide which patterns and styles to hold in inventory, the availability of low-cost imported products and shifts in consumer preferences and styles subject the company to markdowns of inventory.
Management continually examines inventory to determine if there are indicators that the carrying value exceeds its net realizable value. Historical experience has shown that the most significant indicator that would require inventory markdowns is the age of the inventory and the planned discontinuance of certain fabric patterns. As a result, we provide inventory valuation markdowns based upon set percentages for inventory aging categories of six, nine, twelve, and fifteen-months that are determined based on historical experience and judgment. Also, we provide inventory valuation write-downs based on the planned discontinuation of certain products based on current market values at the time of assessment compared with their current carrying values. While management believes that adequate markdowns for inventory have been made in the consolidated financial statements, significant unanticipated changes in demand or changes in consumer tastes and preferences could result in additional inventory markdowns in the future.
43
As of April 30, 2023, and May 1, 2022, the reserve for inventory markdowns was $11.8 million and $7.3 million, respectively.
Refer to Note 5 of the consolidated financial statements for additional disclosures regarding our assessments and conclusions reached regarding substantial losses resulting from the subsequent measurement of inventory.
Income Taxes – Valuation Allowance
We evaluate the realizability of our deferred income taxes to determine if a valuation allowance is required. We are required to assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more-likely-than-not” standard, with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, considering the effects of local tax law.
To determine if a valuation allowance is required or needs to be subsequently reversed, we use significant judgment when considering the effect of all positive and negative evidence identified and giving weight to that evidence. The weight given to the potential effect of positive and negative evidence is based on the extent to which it can be objectively verified. Our judgments are often based on estimates that are derived from (i) forecasted financial information, (ii) assumptions on when certain taxable or deductible events will occur, and (iii) interpretation of complex income tax laws and regulations.
As of April 30, 2023, we recorded a full valuation allowance against all our U.S. net deferred income tax assets totaling $18.7 million.
Refer to Note 11 of the consolidated financial statements for additional disclosures regarding our assessments and conclusions reached regarding our valuation allowance as of April 30, 2023.
Stock-Based Compensation
We are required to recognize compensation expense for all stock-based compensation awards in the financial statements, with the cost measured at the grant date fair value.
Compensation expense for performance-based restricted stock units is recognized based on an assessment each reporting period of the probability of whether or not certain performance targets will be met and how many shares are expected to be earned as of the end of the vesting period. If certain targets are not expected to be achieved, compensation expense will not be recorded, and any previously recognized compensation expense will be reversed. Determining the probability of the vesting of our performance-based restricted stock units requires judgment, including assumptions used to forecast future financial results. While our forecasts of future financial results represent management’s best estimates, these involve inherent uncertainties. As a result, if we revised our assumptions and estimates during the vesting period, our stock-based compensation expense could be materially different than previously expected.
We estimate the fair value of our performance-based restricted stock units that have a market condition using a Monte Carlo valuation model. The Monte Carlo valuation model incorporates inputs and complex assumptions that include (i) the closing price of our common stock at the respective grant date, (ii) expected volatility of our common stock, (iii) expected volatility and correlation coefficient of our peer companies that are approved by the Compensation Committee of our board of directors, (iv) risk-free interest rate, and (v) dividend yield. The determination of the inputs and complex assumptions used, and the application of the Monte Carlo valuation model, requires significant judgment by management and advice from an external advisor.
We recorded $1.1 million, $1.1 million, and $1.3 million of compensation expense within selling, general, and administrative expense for our equity-based awards in fiscal 2023, 2022, and 2021, respectively.
Adoption of New Accounting Pronouncements
Refer to Note 1 of the consolidated financial statements for recently adopted accounting pronouncements for fiscal 2023.
Recently Issued Accounting Standards
Refer to Note 1 of the consolidated financial statements for recently issued accounting pronouncements for fiscal 2024 and beyond.
44