Item 7. Management’s Discussion and Analysis
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 2024, 2023, and 2022 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 manufacturing operations located in Stokesdale, North Carolina, and Quebec, Canada. We also have a mattress cover operation located in Ouanaminthe, Haiti. 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.
On April 29, 2024 (the first quarter of fiscal 2025), our board of directors made a decision to (1) consolidate the company's North American mattress fabrics operations, including a gradual discontinuation of operations and sale of the company's manufacturing facility located in Quebec, Canada; (2) move a portion of the knitting and finishing capacity from the company's manufacturing facility located in Quebec, Canada, to the company's manufacturing facility located in Stokesdale, North Carolina; (3) transition the mattress fabrics segment's weaving operation to a strategic sourcing model through the company's long standing supply partners; and (4) consolidate the company's sewn mattress cover operation located in Ouanaminthe, Haiti, from two leased facilities into one building and reduce other operation expenses at this location. See Note 8 to the consolidated statements regarding our restructuring activities.
Upholstery Fabrics
The upholstery fabrics segment develops, sources, manufactures, and sells fabrics primarily to residential, commercial, and hospitality furniture manufacturers. We have upholstery fabric operations located in Shanghai, China, and Burlington, North Carolina. During the fourth quarter of fiscal 2024, we also established a wholly owned subsidiary, Culp Fabrics Vietnam Limited, with an administrative office located in Ho Chi Minh City, Vietnam, for the purpose of enhancing our strategic sourcing opportunities and to further diversify our supply chain in Asia.
During the third quarter of fiscal 2022, we commenced operation of a new leased facility in Ouanaminthe, Haiti, dedicated to the production of cut and sewn upholstery kits. However, due to a significant decline in demand, we (i) terminated the agreement to lease this new facility during the third quarter of fiscal 2023, (ii) relocated a scaled down upholstery cut and sewn operation into our existing mattress cover facility located in Ouanaminthe, Haiti, during the fourth quarter of fiscal 2023, and (iii) thereafter discontinued the production of cut and sewn upholstery kits in Haiti during the first quarter of fiscal 2024 as a result of a further decline in demand. See Notes 8 and 9 of the consolidated financial statements for further details regarding this restructuring plan.
Additionally, Read Window Products, LLC (“Read”), 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 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.
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. Cost of sales for each segment includes costs to develop, manufacture, or source our products, including costs such as raw material and finished goods purchases, direct and indirect labor, overhead, and incoming freight charges. Unallocated corporate expenses primarily represent compensation and benefits for certain executives and their support staff, all costs associated with being a public company, amortization of intangible assets, and other miscellaneous expenses.
28
Results of Operations
Twelve Months Ended
(dollars in thousands)
April 28,
2024
April 30,
2023
Change
Net sales
$
225,333
$
234,934
(4.1
)%
Gross profit
27,939
10,896
156.4
%
Gross profit margin
12.4
%
4.6
%
780
bp
Selling, general, and administrative expenses
38,611
37,978
1.7
%
Restructuring expense
636
1,396
(54.4
)%
Loss from operations
(11,308
)
(28,478
)
(60.3
)%
Operating margin
(5.0
)%
(12.1
)%
(710
) bp
Loss before income taxes
(10,770
)
(28,390
)
(62.1
)%
Income tax expense
3,049
3,130
(2.6
)%
Net loss
(13,819
)
(31,520
)
(56.2
)%
Net Sales
Our consolidated net sales decreased 4.1% in fiscal 2024 compared with a year ago, with mattress fabric net sales increasing 4.8% and upholstery fabric net sales decreasing 12.1%.
The increase in net sales in our mattress fabrics segment was driven by higher sales for the first nine months of fiscal 2024, primarily due to new fabric and sewn cover placements priced in line with current costs, and, to a lesser extent, SKU rationalization and the re-pricing of some underperforming SKUs to reflect current costs, resulting in higher average selling prices overall. The higher sales in the first nine months of the year were partially offset by lower sales during the fourth quarter, as sales were pressured by weakness in the domestic mattress industry, driven by a challenging macroeconomic environment that affected consumer discretionary spending and housing markets.
The decrease in net sales for our upholstery fabrics segment for fiscal 2024 primarily reflects ongoing softness in the residential home furnishings industry, where demand was pressured throughout the year by a challenging macroeconomic environment that affected consumer discretionary spending and reduced home sales.
See the Segment Analysis located in the Results of Operations section below for further details.
Loss Before Income Taxes
Overall, our consolidated loss before income taxes was $(10.8) million for fiscal 2024, compared with loss before income taxes of $(28.4) for the prior year.
Operating performance for fiscal 2024, as compared to the prior year, was positively affected by a more profitable mix of sales and better inventory management for both the mattress fabrics and upholstery fabrics segment; a more favorable foreign exchange rate associated with our upholstery fabrics operation in China; and fixed cost savings in the upholstery fabrics segment. These factors were partially offset by lower sales during the year, as well as production inefficiencies mostly related to certain new product launches in the mattress fabrics segment. Notably, operating performance for fiscal 2023 was negatively affected by inventory impairment charges and inventory closeout sales for our mattress fabrics segment; higher than normal markdowns of inventory in our upholstery fabrics segment; and restructuring and related charges associated with our upholstery fabrics segment.
See the Segment Analysis located in the Results of Operations section below for further details.
Income Taxes
We recorded income tax expense of $3.0 million, or (28.3)% of loss before income taxes, for fiscal 2024, compared with income tax expense of $3.1 million, or (11.0)% of loss before income taxes, for fiscal 2023.
Our negative consolidated effective income tax rates during fiscal 2024 and fiscal 2023 were caused by the mix of earnings between our U.S. operations and foreign subsidiaries, as our taxable income stems from our operations located in China and Canada, which have higher income tax rates than the U.S. In addition, we applied a full valuation allowance against our U.S. deferred income tax assets
29
during both fiscal 2024 and fiscal 2023. Consequently, an income tax benefit was not recognized for the pre-tax losses associated with our U.S. operations totaling $(18.6) million and $(33.5) million that were incurred during fiscal 2024 and fiscal 2023, respectively.
During fiscal 2024, we incurred a significantly lower consolidated pre-tax loss of $(10.8) million, compared with a significantly higher pre-tax loss of $(28.4) million incurred during fiscal 2023. 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 during fiscal 2024 compared with fiscal 2023.
During fiscal 2024 and fiscal 2023, we had income tax payments totaling $3.3 million and $2.3 million, respectively, which primarily 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.
Liquidity
As of April 28, 2024, our cash and cash equivalents (“cash") totaled $10.0 million, a decrease of $11.0 million compared with cash of $21.0 million as of April 30, 2023. This decrease was mostly due to (i) net cash used in operating activities totaling $8.2 million; and (ii) capital expenditures of $3.7 million mostly related to our mattress fabrics segment; partially offset by (iii) proceeds from the sale of equipment and a note receivable totaling $715,000 (see Note 9 to the consolidated financial statements for further details).
Our net cash used in operating activities was $8.2 million during fiscal 2024, a decrease of $16.0 million compared with net cash provided by operating activities of $7.8 million during fiscal 2023. This trend primarily reflects (i) a significant decrease in inventory during fiscal 2023, which decrease did not recur during fiscal 2024 due to improved alignment of inventory purchases with customer demand trends and promotional programs to reduce aged raw materials and finished goods; (ii) a significant increase in accounts payable during fiscal 2023, related to 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, that did not recur during fiscal 2023 or fiscal 2024; (iii) annual incentive payments made during the first quarter of fiscal 2024, which did not occur during the first quarter of fiscal 2023; and (iv) an increase in income tax payments (see Note 11 to the consolidated financial statements for tabular disclosure of income tax payments by jurisdiction); partially offset by (v) an increase in cash earnings during fiscal 2024 compared with fiscal 2023, and (vi) a decrease in accounts receivable during fiscal 2024, which reflects a 19.4% decrease in net sales during the fourth quarter of fiscal 2024, as compared to the fourth quarter of fiscal 2023.
As of April 28, 2024, there were no outstanding borrowings under our lines of credit.
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
2024
2023
Net sales
100.0
%
100.0
%
Cost of sales
(87.6
)
(95.4
)
Gross profit
12.4
4.6
Selling, general and administrative expenses
(17.1
)
(16.2
)
Restructuring expense
(0.3
)
(0.6
)
Loss from operations
(5.0
)
(12.1
)
Interest expense
—
—
Interest income
0.5
0.2
Other expense
(0.3
)
(0.2
)
Loss before income taxes
(4.8
)
(12.1
)
Income tax expense *
(28.3
)
(11.0
)
Net loss
(6.1
)
(13.4
)
* Calculated as a percentage of loss before income taxes.
30
2024 compared with 2023
Segment Analysis
Mattress Fabrics Segment
Twelve Months Ended
(dollars in thousands)
April 28,
2024
April 30,
2023
Change
Net sales
$
116,370
$
110,995
4.8
%
Gross profit (loss)
6,289
(6,739
)
N.M.
Gross margin
5.4
%
(6.1
)%
N.M.
Selling, general and administrative expenses
13,134
11,942
10.0
%
Loss from operations
(6,845
)
(18,681
)
(63.4
)%
Operating margin
(5.9
)%
(16.8
)%
1090
bp
Net Sales
Mattress fabrics sales increased 4.8% in fiscal 2024 compared to the prior year. This increase was driven by higher sales for the first nine months of fiscal 2024, primarily due to new fabric and sewn cover placements priced in line with current costs, and, to a lesser extent, SKU rationalization and the re-pricing of some underperforming SKUs to reflect current costs, resulting in higher average selling prices as compared to historical average selling prices. The increase in sales during the first nine months of the year was partially offset by lower sales during the fourth quarter, as sales were pressured by weakness in the domestic mattress industry, driven by a challenging macroeconomic environment that affected consumer discretionary spending and housing markets.
The decline in fourth quarter sales, along with ongoing macroeconomic challenges, caused us to take aggressive action to bring our manufacturing costs and capacity in line with current and expected demand. We announced a major restructuring plan primarily focused on the mattress fabrics segment in May 2024 (our fiscal 2025 year), and we are making steady progress on the execution of this restructuring, which is expected to be mostly completed by the end of the calendar year. See “—Restructuring Activities” below for further details.
Looking ahead, we are diligently focused on winning new placements to drive revenue and increase margins. However, with no ascertainable catalysts that might be expected to drive recovery in the near term, we expect the current macroeconomic environment will continue to pressure consumer spending and housing market trends (and our net sales) for some time. In the face of these macro headwinds, we are working to manage the aspects of our business we can control, including the execution of our restructuring plan. We believe the strategic actions we are taking will position us for profitable growth opportunities, but greater macro-industry and end-consumer support will be needed to drive recovery in the mattress industry and support our future sales growth. Additionally, the potential ongoing geopolitical disruptions related to wars in Ukraine and the Middle East, as well as possible economic and health effects from additional surges in the coronavirus, remain unknown and depend on factors beyond our knowledge or control. These situations could cause disruption to global markets that could adversely affect our operations and financial performance.
Gross Profit and Operating Income
The decrease in this segment’s operating loss during fiscal 2024, as compared to fiscal 2023, was primarily due to higher sales through the first nine months of the year as described above, along with better inventory management (i.e., in the prior fiscal year, operating performance was pressured by $2.9 million in inventory impairment charges, $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. These charges, losses from closeout sales, and markdowns did not recur, or were significantly less, in fiscal 2024). These factors were partially offset by production inefficiencies mostly relating to certain new product launches, as well as higher SG&A expense. Higher SG&A expense for fiscal 2024, as compared to fiscal 2023, was primarily due to an increase in trade show expense (in connection with the bi-annual ISPA bedding show); an increase in allowance for customer credit risk; and an increase in sampling expense due to a reorganization of this segment's U.S. cut and sew operation.
We expect the ongoing industry softness affecting sales volumes will affect profitability through at least the first half of fiscal 2025 as we work to implement our restructuring plan to align capacity with current and expected demand. However, we expect these restructuring initiatives, once fully implemented, will enable the mattress fabrics segment to grow more efficiently and profitably with a lower level of fixed costs. See “—Restructuring Activities” below for further details. Importantly, these strategic steps do not limit our ability to grow the mattress fabrics business, but instead allow us to better optimize our global mix of manufacturing capabilities and long-term sourcing partners. We will also consider further adjustments to right-size and restructure our operations as necessary to
31
align with current demand levels, as well as additional reasonable pricing actions as competitive conditions permit to further mitigate and manage inflation.
Restructuring Activities
On April 29, 2024 (first quarter of fiscal 2025), our board of directors made a decision to (1) consolidate the company's North American mattress fabrics operations, including a gradual discontinuation of operations and sale of the company's manufacturing facility located in Quebec, Canada; (2) move a portion of the knitting and finishing capacity from the company's manufacturing facility located in Quebec, Canada, to the company's manufacturing facility located in Stokesdale, North Carolina; (3) transition the mattress fabrics segment's weaving operation to a strategic sourcing model through the company's long standing supply partners; and (4) consolidate the company's sewn mattress cover operation located in Ouanaminthe, Haiti, from two leased facilities into one building and reduce other operating expenses at this location.
We expect the gradual discontinuance of operations and the closure of the facility located in Quebec, Canada, will be completed by December 31, 2024. We expect the consolidation activity associated with the sewn mattress cover operation located in Haiti will be completed during the first quarter of fiscal 2025. These actions are expected to result in estimated restructuring and restructuring related costs and charges of approximately $8.0 million, of which approximately $2.5 million is expected to be cash expenditures. The costs include cash charges of approximately $1.1 million associated with expected ongoing operating losses and other exit and disposal expenses related to the company's manufacturing plant in Quebec, Canada; cash charges of approximately $1.4 million for employee termination costs; a non-cash charge of approximately $2.3 million associated with accelerated depreciation and losses on the sale of equipment; a non-cash charge of approximately $2.1 million associated with write-downs and other inventory related adjustments; and a non-cash charge of approximately $650,000 associated with accelerated rent amortization for a leased building in Haiti. These restructuring charges and restructuring related costs and charges exclude any expected gain on the sale of real estate associated with the closure of the Canadian facility, the amount of which is currently undetermined but which will ultimately reduce the amount of the restructuring charges incurred (and based on management's internal analysis, we expect cash proceeds from the sale of real estate (net of all taxes and commissions) to exceed the amount of restructuring charges incurred). Also, management estimates that the realizable fair market value of the long-lived assets at the Canadian and Haitian facilities exceed their net book value, and for that reason, no charges for impairment of long-lived assets (other than the restructuring charges noted above) are expected to be recorded in the connection with this decision for either location.
Based on changes in business and current industry economic conditions, it is possible that the above estimates provided by management to determine the restructuring and restructuring related charges and estimated cash proceeds generated from the sale of the manufacturing facility located in Quebec, Canada, could be materially different from our actual results, and therefore could adversely affect the success of this restructuring plan.
Segment Assets
Segment assets consist of accounts receivable, inventory, property, plant, and equipment, and right of use assets.
(dollars in thousands)
April 28,
2024
April 30,
2023
% Change
Accounts receivable
$
10,003
$
12,396
(19.3
)%
Inventory
27,671
25,674
7.8
%
Property, plant & equipment
31,472
33,749
(6.7
)%
Right of use assets
1,627
2,308
(29.5
)%
Total mattress fabrics segment assets
$
70,773
$
74,127
(4.5
)%
Refer to Note 17 of the consolidated financial statements for disclosures regarding determination of our segment assets.
Accounts Receivable
The decrease in accounts receivable reflects the decrease in net sales during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023. Net sales during the fourth quarter of fiscal 2024 were $25.8 million, a decrease of (16.1)% compared with net sales of $30.7 million during the fourth quarter of fiscal 2023. In addition, we experienced faster cash collections from a significant customer who utilized more cash discounts during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023. This led to a decrease in days' sales outstanding from 37 days during the fourth quarter fiscal 2023, as compared with 35 days during the fourth quarter of fiscal 2024.
32
Inventory
The increase in inventory primarily reflects lower than anticipated demand trends in relation to inventory purchases and production during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023. Net sales during the fourth quarter of fiscal 2024 were $25.8 million, a decrease of 16.1% compared with net sales of $30.7 million during the fourth quarter of fiscal 2023.
Inventory turns were 3.6 for the fourth quarter of fiscal 2024, compared with 4.4 for the fourth quarter of fiscal 2023.
Property, Plant, & Equipment
The decrease in property, plant, and equipment represents a continued maintenance level of capital spending with a strategic focus on capital projects that will increase efficiencies and improve the quality of our products.
The $31.5 million as of April 28, 2024, represents property, plant, and equipment of $21.5 million, $9.4 million, and $555,000 located in the U.S., Canada, and Haiti, respectively. 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.
Right of Use Assets
The decrease in right of use assets stems from rent expense incurred over the terms of the respective lease agreements.
The $1.6 million as of April 28, 2024, represents right of use assets of $1.1 million and $545,000 located in Haiti and Canada, respectively. The $2.3 million as of April 30, 2023, represents right of use assets of $1.5 million and $776,000 located in Haiti and Canada, respectively.
Upholstery Fabrics Segment
Net Sales
Twelve Months Ended
(dollars in thousands)
April 28,
2024
April 30,
2023
% Change
Non-U.S. Produced
$
98,429
90
%
$
114,589
92
%
(14.1
)%
U.S. Produced
10,534
10
%
9,350
8
%
12.7
%
Total
$
108,963
100
%
$
123,939
100
%
(12.1
)%
Upholstery fabrics sales decreased 12.1% in fiscal 2024 compared to the prior year. This decrease primarily reflects ongoing softness in the residential home furnishings industry, where demand was pressured throughout the year by a challenging macroeconomic environment that affected consumer discretionary spending and reduced home sales. Sales during the prior year were also positively affected by receipt of a $1.0 million non-recurring payment (relating to newly negotiated terms with a Haiti cut and sew customer) that did not recur during fiscal 2024.
Looking ahead, we expect the soft industry demand backdrop for residential home furnishings may affect 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, supported by our flexible Asian platform and our long-term supplier relationships. We also believe overall demand remains solid for our hospitality/contract business.
Notably, the potential ongoing geopolitical disruptions related to wars in Ukraine and the Middle East, 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 any of these situations, including additional COVID-related shutdowns of our China operations or shipping disruptions related to wars in the Middle East, the impact on our operations, and/or on our suppliers, customers, consumers, and the global economy, could adversely affect our financial performance.
33
Gross Profit and Operating Income
Twelve Months Ended
(dollars in thousands)
April 28,
2024
April 30,
2023
Change
Gross profit
$
21,690
$
17,733
22.3
%
Gross profit margin
19.9
%
14.3
%
560
bp
Selling, general and administrative expenses
15,903
15,739
1.0
%
Restructuring expense
636
1,396
(54.4
)%
Income from operations
5,787
1,994
190.2
%
Operating margin
5.3
%
1.6
%
370
bp
The increase in upholstery fabrics profitability for fiscal 2024, as compared to fiscal 2023, primarily reflects a more profitable mix of sales; better inventory management (i.e., in the prior fiscal year, operating performance was pressured by $2.5 million in markdowns of inventory based on our policy for aged inventory, while such markdowns were significantly lower in fiscal 2024); a more favorable foreign exchange rate in China; and lower fixed costs resulting from the previous restructuring of the upholstery fabrics cut and sew platform. These factors were partially offset by lower sales during the year.
Based on market dynamics, we took action during the fourth quarter of fiscal 2024 to restructure our upholstery fabrics finishing operation in China to align with current demand and further leverage our strategic supply relationships (see below). We believe this move will allow us to reduce our operating costs while maintaining our ability to support our customers.
Looking ahead, the residential home furnishings industry remains under pressure due to shifting consumer spending trends, inflation, reduced home sales, and other macroeconomic conditions affecting discretionary consumer spending. As a result, we expect lower sales volumes in our residential business will continue to affect our profitability. However, for fiscal 2025, we expect to benefit from continued solid demand in our hospitality/fabrics business; improvement in our Read Window business; and fixed cost savings from our strategic decision to rationalize our upholstery fabric finishing operation in China and further leverage our long-term supply relationships. We will also continue our ongoing cost reduction efforts and will consider further adjustments to rationalize our operations as necessary to align with current demand levels, while maintaining our ability to service our customers.
Restructuring Activities
Ouanaminthe, Haiti
During the third quarter of fiscal 2023, Culp Upholstery Fabrics Haiti, Ltd. ("CUF Haiti") entered into an agreement to terminate a lease associated with a facility, and in turn moved the production of upholstery cut and sewn kits to an existing facility leased by Culp Home Fashions Haiti, Ltd. ("CHF Haiti") during the fourth quarter of fiscal 2023. Both CUF Haiti and CHF Haiti are indirect wholly owned subsidiaries of the company. During the first quarter of fiscal 2024, demand for upholstery cut and sewn kits declined more than previously anticipated, resulting in the strategic action to discontinue the production of upholstery cut and sewn kits in Haiti.
This restructuring activity was completed during the third quarter of fiscal 2024, and we incurred a cumulative restructuring and restructuring related charge of $1.3 million from the commencement of this restructuring activity during the third quarter of fiscal 2023 through the third quarter of fiscal 2024.
See Note 9 of the consolidated financial statements for further details regarding the agreement to terminate the above mentioned lease agreement and a related note receivable.
Shanghai, China
Cut and Sew Upholstery Fabrics Operation
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 taken in order to adjust our operating costs to better align with the declining demand for cut and sewn products. This restructuring
34
activity was completed during the third quarter of fiscal 2023, and we incurred a cumulative restructuring and restructuring related charge of $713,000 during the second and third quarters of fiscal 2023.
Upholstery Fabrics Finishing Operation
During the fourth quarter of fiscal 2024, we rationalized our upholstery fabrics finishing operation located in Shanghai, China, to align with current demand trends and further leverage our strategic supply relationships. This restructuring activity is expected to be completed by the end of the first quarter of fiscal 2025.
The following summarizes our restructuring expense and restructuring related charges from the restructuring activities noted above for the twelve months ending April 28, 2024, and April 30, 2023:
(dollars in thousands)
2024
2023
Employee termination benefits
$
307
$
507
Lease termination costs
—
481
Impairment loss - leasehold improvements and equipment
329
357
Loss on disposal and markdowns of inventory
40
98
Other associated costs
—
51
Restructuring expense and restructuring related charges (1)(2)
$
676
$
1,494
(1) Of the total $676,000 for fiscal 2024, $636,000 and $40,000 were recorded within restructuring expense and cost of sales, respectively, in the Consolidated Statement of Net Loss for the twelve-month period ending April 28, 2024.
(2) Of the total $1.5 million for fiscal 2023, $1.4 million and $98,000 were recorded within restructuring expense and cost of sales, respectively, in the Consolidated Statement of Net Loss for the twelve-month period ending April 30, 2023.
Segment Assets
Segment assets consist of accounts receivable, inventory, property, plant, and equipment, and right of use assets.
(dollars in thousands)
April 28,
2024
April 30,
2023
% Change
Accounts receivable
$
11,135
$
12,382
(10.1
)%
Inventory
17,172
19,406
(11.5
)%
Property, plant & equipment
1,125
1,671
(32.7
)%
Right of use assets
1,952
2,618
(25.4
)%
Total upholstery fabrics segment assets
$
31,384
$
36,077
(13.0
)%
Accounts Receivable
The decrease in accounts receivable reflects the decrease in net sales during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023. Net sales during the fourth quarter of fiscal 2024 were $23.8 million, a decrease of 22.6% compared with net sales of $30.7 million during the fourth quarter of fiscal 2023. The decrease was partially offset by slower cash collections during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023, due to an unfavorable sales mix with customers with longer credit terms. This led to an increase in days' sales outstanding to 37 days during the fourth quarter fiscal 2024, as compared with 33 days during the fourth quarter of fiscal 2023.
Inventory
The decrease in inventory reflects the decrease in net sales during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023. Net sales during the fourth quarter of fiscal 2024 were $23.8 million, a decrease of 22.6% compared with net sales of $30.7 million during the fourth quarter of fiscal 2023.
Inventory turns were 4.4 during the fourth quarter of fiscal 2024, compared with 4.8 for the fourth quarter of fiscal 2023.
Property, Plant, & Equipment
The decrease in property, plant, and equipment represents an impairment charge related to equipment of $329,000 resulting from the discontinuation of production of cut and sewn upholstery kits at the company's facility located in Ouanaminthe, Haiti, and continued maintenance level of capital spending as a result of the current and expected unfavorable industry conditions.
35
The $1.1 million as of April 28, 2024, represents property, plant, and equipment of $1.0 million and $120,000 located in the U.S. and China, respectively. 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.
Right of Use Assets
The decrease in right of use assets reflects rent expense incurred over the terms of our existing lease agreements, partially offset by the renewal of our agreement to lease a facility with Read and certain facilities associated with our operations located in China.
The $2.0 million as of April 28, 2024, represents right of use assets of $1.3 million and $709,000 located in the U.S. and China, respectively. 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.
Other Income Statement Categories
Twelve Months Ended
(dollars in thousands)
April 28,
2024
April 30,
2023
% Change
Selling, general, and administrative expenses
$
38,611
$
37,978
1.7
%
Interest expense
11
—
100.0
%
Interest income
1,174
531
121.1
%
Other expense
625
443
41.1
%
Selling, General, and Administrative Expenses
The modest increase in selling, general, and administrative expenses during fiscal 2024, as compared with fiscal 2023, is due to a variety of factors, including (i) wage inflation; (ii) an increase in travel, entertainment, and trade show expenses; (iii) an increase in allowance for customer credit risk; and (iv) an increase in sampling expense due to a reorganization of the mattress fabric segment's U.S. cut and sew operation; mostly offset by (v) $1.3 million in lower compensation expense, reflecting unfavorable financial results in relation to pre-established targets.
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 2024, as compared with fiscal 2023.
Other Expense
The increase in other expense in fiscal 2024, as compared to fiscal 2023, is primarily due to the increase in fees and other costs associated with our ABL Credit agreement effective on January 19, 2023. See Note 10 located in the consolidated financial statements for further details regarding the terms and covenants associated with the ABL Credit Agreement.
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, Canada, and Vietnam.
During fiscal 2024, other expense included a foreign exchange rate gain of $545,000, compared with a foreign exchange rate gain of $500,000 during fiscal 2023. The $545,000 and $500,000 foreign exchange rate gains reported in fiscal 2024 and fiscal 2023 mostly relate to 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 2024, we recorded a foreign exchange rate gain of $604,000 related to our operations located in China, which was mostly non-cash and was offset by $541,000 of income tax expense. This income tax expense of $541,000 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.
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Income Taxes
Effective Income Tax Rate & Income Tax Expense
We recorded income tax expense of $3.0 million, or (28.3)% of loss before income taxes, during fiscal 2024, compared with income tax expense of $3.1 million, or (11.0)% of loss before income taxes, during fiscal 2023.
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:
2024
2023
U.S. federal income tax rate
21.0
%
21.0
%
valuation allowance
(30.9
)
(24.0
)
foreign tax rate differential
(4.7
)
(4.0
)
income tax effects of Chinese foreign exchange gains and losses
(3.6
)
(0.9
)
withholding taxes associated with foreign tax jurisdictions
(6.5
)
(2.4
)
uncertain income tax positions
(0.7
)
(0.3
)
U.S. state income taxes
0.8
0.6
stock-based compensation
(1.8
)
(0.3
)
other (1)
(1.9
)
(0.7
)
consolidated effective income tax rate (2) (3)
(28.3
)%
(11.0
)%
(1) “Other” for all periods presented represents miscellaneous adjustments that pertain to U.S. permanent differences such as meals and entertainment expense and income tax provision to return adjustments.
(2) Our negative consolidated effective income tax rates during fiscal 2024 and fiscal 2023 were caused by the mix of earnings between our U.S. operations and foreign subsidiaries, as our taxable income stems from our operations located in China and Canada, which have higher income tax rates than the U.S. In addition, we applied a full valuation allowance against our U.S. deferred income tax assets during both fiscal 2024 and fiscal 2023. Consequently, an income tax benefit was not recognized for the pre-tax losses associated with our U.S. operations totaling $(18.6) million and $(33.5) million that were incurred during fiscal 2024 and fiscal 2023, respectively.
(3) During fiscal 2024, we incurred a significantly lower consolidated pre-tax loss of $(10.8) million, compared with a significantly higher pre-tax loss of $(28.4) million incurred during fiscal 2023. 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 during fiscal 2024 compared with fiscal 2023.
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 28, 2024, 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 2025. 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 $22.0 million as of April 28, 2024.
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 28, 2024, 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
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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 28, 2024, we recorded a deferred income tax liability associated with our undistributed earnings from foreign subsidiaries of $4.8 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 28, 2024, we had a $1.3 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, a significant change associated with this income tax benefit is not expected within the next fiscal year.
United States 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 2020 and subsequent. Canadian provincial (Quebec) income tax returns filed by us remain subject to examination for income tax years 2020 and subsequent. Income tax returns associated with our operations located in China are subject to examination for income tax year 2019 and subsequent.
Refer to Note 11 of the consolidated financial statements for disclosures and additional information regarding our uncertain income tax positions.
Income Taxes Paid
The following table sets forth income taxes paid by jurisdiction:
(dollars in thousands)
2024
2023
United States Federal - Transition Tax
499
265
China - Income Taxes
2,317
1,831
Canada - Income Taxes
468
228
$
3,284
$
2,324
Future Liquidity
Based on the restructuring plan approved by our board of directors on April 29, 2024, the timing and success of the closure of our Canadian operation, along with the sale of associated real estate (the timing and amount of which sales price is currently undetermined), could have a significant effect on (i) the amount and timing of when and if fiscal 2025 income tax payments will be required (ii) the amount and timing of withholding tax payments to the Canadian government associated with the repatriation of earnings and profits to the U.S. parent, and (iii) the respective tax rates that will be applied based on the sale of real estate and equipment. Accordingly, we believe we cannot provide a reasonable estimate of our fiscal 2025 income tax payments associated with our Canadian operation at this time.
Currently, we are projecting annual cash income tax payments of approximately $1.9 million associated with our operations located in China. This estimate is management's current projection only and can be affected by actual earnings versus annual projections, changes in the foreign exchange rates in relation to the U.S. dollar, and the timing of when we will repatriate earnings and profits from China to our U.S. parent.
Currently do not expect to incur any income taxes in the U.S. on a cash basis during fiscal 2025 due to (i) the accelerated expensing of U.S. capital expenditures, and (ii) our existing U.S. federal net operating loss carryforwards. In accordance with the 2017 Tax Cuts and Jobs Act, we will be required to pay annual U.S. federal transition tax payments as follows: FY 2025- $665,000; and FY 2026 - $831,000.
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2023 compared with 2022
For a comparison of our results of operations for the fiscal years ended April 30, 2023, and May 1, 2022, 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 April 30, 2023, filed with the SEC on July 14, 2023.
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 28, 2024, we believe our cash of $10.0 million, cash flow from operations, and the current availability under our revolving credit lines totaling $22.5 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 28, 2024, our cash totaled $10.0 million, a decrease of $11.0 million compared with cash of $21.0 million as of April 30, 2023. This decrease was mostly due to (i) net cash used in operating activities totaling $8.2 million; (ii) capital expenditures of $3.7 million mostly related to our mattress fabrics segment; partially offset by (iii) proceeds from the sale of equipment and a note receivable totaling $715,000 (see Note 9 to the consolidated financial statements for further details).
Our net cash used in operating activities was $8.2 million during fiscal 2024, a decrease of $16.0 million compared with net cash provided by operating activities of $7.8 million during fiscal 2023. This trend primarily reflects (i) a significant decrease in inventory during fiscal 2023, which decrease did not recur during fiscal 2024 due to improved alignment of inventory purchases with customer demand trends and promotional programs to reduce aged raw materials and finished goods; (ii) a significant increase in accounts payable during fiscal 2023, related to 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, that did not recur during fiscal 2023 or fiscal 2024; (iii) annual incentive payments made during the first quarter of fiscal 2024, which payments did not occur during the first quarter of fiscal 2023; and (iv) an increase in income tax payments (see Note 11 to the consolidated financial statements for tabular disclosure of income tax payments by jurisdiction); partially offset by (v) an increase in cash earnings during fiscal 2024 compared with fiscal 2023, and (vi) a decrease in accounts receivable during fiscal 2024, which reflects a 19.4% decrease in net sales during the fourth quarter of fiscal 2024, as compared to the fourth quarter of fiscal 2023.
As of April 28, 2024, there were no outstanding borrowings under our lines of credit.
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 balance may be adversely affected by factors beyond our control, such as (i) recent customer demand trends affecting sales, (ii) supply chain disruptions, (iii) rising interest rates and inflation, (iv) world events (including wars in Ukraine and the Middle East), 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 28,
April 30,
(dollars in thousands)
2024
2023
United States
$
2,912
$
9,769
China
6,554
10,669
Canada
371
281
Haiti
86
236
Vietnam
81
—
Cayman Islands
8
9
$
10,012
$
20,964
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Dividend Program
On June 29, 2022 (fiscal 2023), our board of directors announced the decision to suspend the company’s quarterly cash dividend. We believed that preserving capital and managing our liquidity 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 2024 or fiscal 2023.
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 repurchased 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 such purchases are based on working capital requirements, market and general business conditions, and other factors, including alternative investment opportunities.
During fiscal 2024 and fiscal 2023, we did not repurchase any shares of our common stock. As a result, as of April 28, 2024, $3.2 million was available for additional repurchases of our common stock. Despite the current share repurchase authorization, the company does not expect to repurchase any shares through at least the first quarter of fiscal 2025.
Working Capital
Operating Working Capital
Operating working capital (accounts receivable and inventories, less deferred revenue, accounts payable-trade, and accounts payable-capital expenditures) was $38.5 million as of April 28, 2024, compared with $39.2 million as of April 30, 2023. Operating working capital turnover was 5.8 during the fourth quarter of fiscal 2024 compared with 4.6 during the fourth quarter fiscal 2023.
Accounts Receivable
Accounts receivable as of April 28, 2024, were $21.1 million, a decrease of $3.6 million, or 14.7%, compared with $24.8 million as of April 30, 2023. This trend reflects a decrease in net sales during the fourth quarter of fiscal 2024 compared with the fourth quarter of fiscal 2023. Net sales for the fourth quarter of fiscal 2024 were $49.5 million, a decrease of $11.9 million, or 19.4%, compared with net sales of $61.4 million during the fourth quarter of fiscal 2023. See the Executive Summary for section titled “Net Sales” of this Item 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION for further discussion regarding the decline in net sales.
Days’ sales outstanding were 36 days and 35 days for the fourth quarter of fiscal 2024 and fiscal 2023, respectively.
Inventory
Inventories as of April 28, 2024, were $44.8 million, which is comparable with $45.1 million as of April 30, 2023. This trend represents a $2.2 million decrease in inventory related to the upholstery fabrics segment as a result of the decrease in net sales during the fourth quarter of fiscal 2024, compared with the fourth quarter of fiscal 2023. Upholstery fabrics net sales during the fourth quarter of fiscal 2024 were $23.8 million, a decrease of 22.6% compared with net sales of $30.7 million during the fourth quarter of fiscal 2023. The decrease in inventory related to the upholstery fabrics segment was partially offset by a $2.0 million increase in inventory related to the mattress fabrics segment. The increase in inventory related to the mattress fabrics segment primarily reflects lower than anticipated demand trends in relation to inventory purchases during the fourth quarter of fiscal 2024, as compared with the fourth quarter of fiscal 2023. Mattress fabrics net sales during the fourth quarter of fiscal 2024 were $25.8 million, a decrease of 16.1%, compared with net sales of $30.7 million during the fourth quarter of fiscal 2023.
Inventory turns were 3.9 for the fourth quarter of fiscal 2024, compared with 4.7 for the fourth quarter of fiscal 2023.
Accounts Payable-Trade
Accounts payable - trade were $25.6 million as of April 28, 2024, a decrease of $3.8 million, or 13.0%, compared with $29.4 million as of April 30, 2023. The decrease in accounts payable as of April 28, 2024, compared to April 30, 2023, is mostly due to lower inventory
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purchases in both the U.S. and China resulting from weaker customer demand in fourth quarter of fiscal 2024 as compared with 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 28, 2024, 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 28, 2024, 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 28, 2024, and April 30, 2023, we had total amounts due regarding capital expenditures totaling $343,000 and $56,000, respectively, which pertained to outstanding vendor invoices, none of which were financed.
Uncertain Income Tax Positions
As of April 28, 2024, we had $1.3 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.
Capital Expenditures and Depreciation Expense
Capital expenditures on a cash basis totaled $3.7 million and $2.1 million during fiscal 2024 and fiscal 2023, respectively. Capital expenditures during fiscal 2024 and fiscal 2023 mostly related to our mattress fabrics segment and represent a maintenance level of capital spending with a strategic focus on capital projects that will increase efficiencies and improve the quality of our products.
Depreciation expense was $6.5 million during fiscal 2024, compared with $6.8 million during fiscal 2023. Depreciation expense for fiscal 2024 and fiscal 2023 mostly related to our mattress fabrics segment.
Based on current expectations, capital spending for fiscal 2025 is projected to be approximately $4.5 million and will center on capital projects that will increase efficiencies and improve the quality of our products. 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 $4.6 million during fiscal 2024 and $4.2 million during fiscal 2023. 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 $23.3 million, or 10.3% of net sales, during fiscal 2024, and $6.7 million, or 2.8% of net sales, during fiscal 2023.
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.
During fiscal 2023 and continuing through fiscal 2024, raw material costs started to decline due to slowing global demand; however, the cost of labor remained challenging during fiscal 2023 and continuing through fiscal 2024.
41
Inflationary pressures also affected consumer spending during fiscal 2023 and continued through fiscal 2024, causing a slowdown in business in both the mattress industry and the residential home furnishings industry. This slowdown has caused reduced demand from producers of home furnishings for our mattress fabrics and residential upholstery fabrics products during fiscal 2023 and fiscal 2024.
We are unable to predict how long these trends will last, or to what extent inflationary pressures may affect the economic and purchasing cycle for home furnishings products (and therefore affect demand for our products) over the short and long-term.
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 28, 2024, 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 indicators that would require inventory markdowns are 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.
As of April 28, 2024, and April 30, 2023, the reserve for inventory markdowns was $9.6 million and $11.8 million, respectively.
Refer to Note 4 of the consolidated financial statements for additional disclosures regarding our assessments and conclusions reached regarding 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 28, 2024, we recorded a full valuation allowance against all our U.S. net deferred income tax assets totaling $22.0 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 28, 2024.
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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 $915,000, $1.1 million, and $1.1 million of compensation expense within selling, general, and administrative expense for our equity-based awards in fiscal 2024, 2023, and 2022, respectively.
Adoption of New Accounting Pronouncements
Refer to Note 1 of the consolidated financial statements for recently adopted accounting pronouncements for fiscal 2024.
Recently Issued Accounting Standards
Refer to Note 1 of the consolidated financial statements for recently issued accounting pronouncements for fiscal 2025 and beyond.