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 2022, 2021, and 2020 included 52 weeks, 52 weeks, and 53 weeks, respectively.
Our operations are classified into two business segments: mattress fabrics and upholstery fabrics.
The mattress fabrics segment manufactures, sources, and sells fabrics and mattress covers primarily to bedding manufacturers. We have mattress fabric operations located in Stokesdale, NC, High Point, NC, and Quebec, Canada. 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).
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, NC. 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. Additionally, Read Window Products, LLC (“Read”), a wholly-owned subsidiary with operations located in Knoxville, TN, provides window treatments and sourcing of upholstery fabrics and other products, as well as measuring and installation services of 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
For a discussion of how COVID-19 has affected and may continue to affect our business and financial condition, see the discussion under the heading “COVID-19 Impact and Business Response” in Part I, Item 1 of this report, as well as 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. 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)
May 1,
2022
May 2,
2021
Change
Net sales
$
294,839
$
299,720
(1.6
)%
Gross profit
36,093
49,832
(27.6
)%
Gross profit margin
12.2
%
16.6
%
(440
) bp
Selling, general, and administrative expenses
35,415
37,756
(6.2
)%
Income from operations
678
12,076
(94.4
)%
Operating margin
0.2
%
4.0
%
(380
) bp
(Loss) income before income taxes
(325
)
10,880
(103.0
)%
Income tax expense
2,886
7,693
(62.5
)%
Net (loss) income
(3,211
)
3,218
(199.8
)%
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Net Sales
Overall, our net sales decreased 1.6% in fiscal 2022 compared with a year ago, with mattress fabric net sales decreasing 3.5% and upholstery fabric net sales increasing 0.4%. Fiscal 2021 was negatively affected by the economic disruption caused by the COVID-19 pandemic during the first quarter.
The decrease in net sales for our mattress fabrics segment during fiscal 2022 reflects the significant drop in sales during the fourth quarter of fiscal 2022, driven primarily by weakness in domestic mattress industry sales that caused customers to curtail inventory purchases and delay the timing of new product rollouts in response to slowing retail demand. Sales were also affected by the COVID-related shutdowns of the company’s operations in China, which halted production and distribution of sewn mattress covers produced in China throughout the month of April. The decrease in net sales was partially offset by pricing and surcharge actions that were in effect during the year, including a price increase that was effective throughout the year, as well as a materials surcharge (inclusive of freight) that was implemented during the second quarter, an additional selective price increase that was implemented during the third quarter, and additional targeted price increases on certain products implemented during the fourth quarter. Together, these pricing actions increased net sales for the division by approximately 5.1% during fiscal 2022.
The increase in upholstery fabrics net sales during fiscal 2022 reflects higher demand for our residential upholstery products primarily during the first quarter, as compared to the prior-year first quarter, which was negatively affected by disruption from the COVID-19 pandemic. This increase was partially offset by a significant drop in sales for residential upholstery fabric products during the fourth quarter due to COVID-related shutdowns of our facilities in China throughout the month of April and, to a lesser extent, a slowdown in new business for the residential home furnishings industry during the fourth quarter. It was also offset by lower sales in our residential business during the second quarter, primarily due to COVID-19 related shutdowns of our sourcing partners and customers in Vietnam, as well as lower sales for Read in our hospitality business during the first six months of fiscal 2022. The increase in net sales also reflects the impact of pricing and freight surcharge actions that were in effect during the year, including a price increase that was effective throughout the year on products sold in the U.S. to help offset unfavorable foreign currency exchange rate fluctuations associated with our operations in China; a freight surcharge implemented during the second quarter; and an additional price increase implemented on new orders beginning in the third quarter. Together, these price increases and freight surcharge accounted for approximately 2.9% of net sales for the division during fiscal 2022.
See the Segment Analysis located in the Results of Operations section below for further details.
Income Before Income Taxes
Overall, our loss before income taxes was $(325,000) for fiscal 2022, compared with income before income taxes of 10.9 million for the prior year. The results for fiscal 2021 include an $819,000 gain on bargain purchase associated with our fourth-quarter acquisition of the remaining fifty percent ownership interest in our former unconsolidated joint venture located in Haiti.
Operating performance for fiscal 2022 was materially affected by lower sales; operating inefficiencies at our mattress fabrics segment’s U.S. and Canadian locations due to the rapid and material decline in revenues during the fourth quarter; and higher freight, raw material, and labor costs. Other pressures affecting the year were start-up costs for the new Haiti upholstery cut and sew facility, operating inefficiencies in our mattress fabrics segment related to product mix within the segment’s global platform, unfavorable foreign exchange rate fluctuations in China and Canada, labor shortages in the U.S. and Canada, and additional employee training costs and operating inefficiencies at our new Haiti upholstery cut and sew facility. These pressures were partially offset by lower total SG&A expense for the year, due primarily to lower incentive compensation expense.
See the Segment Analysis located in the Results of Operations section below for further details.
Income Taxes
We recorded income tax expense of $2.9 million, or (888.0%) of loss before income taxes, during fiscal 2022, compared with income tax expense of $7.7 million, or 70.7% of income before income taxes, during fiscal 2021. Our effective income tax rates for fiscal 2022 and 2021 were negatively affected by the mix of (loss) income before income taxes, as significant pre-tax losses were incurred by our U.S. operations and almost all our taxable income was earned by our foreign operations located in China and Canada, which have higher income tax rates than the U.S. As a result, income tax expense incurred stems from taxable income from our foreign jurisdictions that exceeds our consolidated (loss) income before income taxes. Accordingly, the extent of the fluctuations in our effective income tax rates is dependent on the extent to which income tax expense incurred from foreign operations compares with our consolidated (loss) income before income taxes, which has been significantly lowered by our U.S. operations.
In addition, income tax expense during fiscal 2021 included a $4.9 million net income tax charge, which consisted of an $8.5 million non-cash income tax charge to record a full valuation allowance against the company’s U.S. net deferred income tax assets, partially offset by a $3.6 million non-cash income tax benefit to re-establish certain U.S. Federal net operating loss carryforwards in connection with U.S. Treasury regulations enacted during the first quarter of fiscal 2021 regarding the Global Intangible Low Taxed Income (“GILTI”) tax provisions of the Tax Cuts and Jobs Act of 2017 (“TCJA”).
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During fiscal 202 2 , we had income tax payments totaling $3. 1 million , which mostly represented income tax payments associated with our foreign operations in China and Canada. During fiscal 2021, we had income tax payments totaling $ 3.0 million , which mostly represented income tax payments of $4.3 million associated with our foreign operations located in China and Canada, partially offset by income tax refunds of $1.5 million that were associated with our U.S. AMT credit carryforward balance .
Refer to Note 12 of the consolidated financial statements for further details regarding our provision for income taxes from operations.
Liquidity
As of May 1, 2022, our cash and cash equivalents, short-term investments (available for sale), and short-term and long-term investments (held-to-maturity) (collectively “cash and investments”) totaled $14.6 million compared with $46.9 million as of May 2, 2021.
The decrease in our cash and investments from the end of fiscal 2021 was mostly due to (i) $5.7 million of capital expenditures primarily related to equipment associated with our mattress fabrics segment, our innovation campus located in downtown High Point, NC, and new equipment associated with information technology, (ii) cash payments totaling $5.5 million for regular quarterly dividend payments to shareholders, (iii) common stock repurchases totaling $1.8 million, (iv) $1.1 million of contributions to our rabbi trust that funds our deferred compensation plan, and (v) net cash used in operating activities totaling $17.4 million.
Our net cash used in operating activities was $17.4 million during fiscal 2022, compared with net cash provided by operating activities of $21.5 million during fiscal 2021. This difference was due mostly to (i) a net increase in cash that was generated during fiscal 2021 due to a significant surge in customer demand as a result of the focus-on-the-home trend that occurred as businesses began to re-open coming out of pandemic-related closures, which such surge did not recur during fiscal 2022; (ii) a decrease in accounts payable due to the significant decrease in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021, as noted above, and due to our return to normal credit terms with our vendors, as opposed to the extended terms previously granted in response to the COVID-19 pandemic; (iii) an increase in inventory due to higher material costs, as well as an increase in inventory purchases to protect against supply chain disruption and support our customers; (iv) a decrease in accrued expenses primarily due to annual incentive bonus compensation paid during the first quarter of fiscal 2022; (v) $1.9 million in payments for the new building lease and start-up expenses associated with our upholstery fabrics cut and sew operation located in Haiti; partially offset by (vi) a decrease in accounts receivable related to the decrease in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021, as noted above, and due to our customers’ return to normal credit terms, rather than the extended terms previously granted in response to the COVID-19 pandemic.
As of May 1, 2022, there were no outstanding borrowings under our lines of credit.
Dividend Program
On June 29, 2022, our board of directors announced the decision to suspend the company’s quarterly cash dividend. Considering the current and expected macroeconomic conditions, we believe that preserving capital and managing liquidity is in the company’s best interest to support future growth and the long-term interests of our shareholders.
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.
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 and timing of share purchases are based on working capital requirements, market and general business conditions, and other factors, including alternative investment opportunities.
During fiscal 2022, we repurchased 121,688 shares of our common stock at a cost of $1.8 million. As a result, as of May 1, 2022, $3.2 million is 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 2023.
During fiscal 2021, we did not repurchase any shares of common stock.
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Results of Operations
The following table sets forth certain items in our consolidated statements of net (loss) income as a percentage of net sales.
Fiscal
Fiscal
2022
2021
Net sales
100.0
%
100.0
%
Cost of sales
(87.8
)
(83.4
)
Gross profit
12.2
16.6
Selling, general and administrative expenses
(12.0
)
(12.6
)
Income from operations
0.2
4.0
Interest expense
—
—
Interest income
0.1
0.1
Gain on bargain purchase
—
0.3
Other expense
(0.5
)
(0.7
)
(Loss) income before income taxes
(0.1
)
3.6
Income tax expense *
(888.0
)
70.7
Income from investment in unconsolidated joint venture
—
—
Net (loss) income
(1.1
)
1.1
*
Calculated as a percentage of (loss) income before income taxes.
2022 compared with 2021
Segment Analysis
Mattress Fabrics Segment
Twelve Months Ended
(dollars in thousands)
May 1,
2022
May 2,
2021
Change
Net sales
$
152,159
$
157,671
(3.5
)%
Gross profit
16,458
23,864
(31.0
)%
Gross profit margin
10.8
%
15.1
%
(430
) bp
Selling, general and administrative expenses
12,246
12,066
1.5
%
Income from operations
4,212
11,798
(64.3
)%
Operating margin
2.8
%
7.5
%
(470
) bp
Net Sales
Mattress fabrics sales decreased 3.5% in fiscal 2022 compared to the prior year. These results reflect the significant drop in sales during the fourth quarter of fiscal 2022, which was primarily driven by weakness in domestic mattress industry sales. We experienced a rapid drop in demand during the fourth quarter, particularly during the month of April, causing customers to curtail inventory purchases and delay the timing of new product rollouts in response to slowing retail demand. We believe this industry softness was primarily due to inflationary pressures affecting consumer spending. Sales during the fourth quarter were also affected by the COVID-related shutdowns of the company’s operations in China, which halted production and distribution of our sewn mattress covers produced in China throughout the month of April.
The decrease in net sales for fiscal 2022 was partially offset by pricing and surcharge actions that were in effect during the year, including a price increase that was effective throughout the year, as well as a materials surcharge (inclusive of freight) that was implemented during the second quarter, an additional selective price increase that was implemented during the third quarter, and additional targeted price increases on certain products implemented during the fourth quarter. Together, these pricing actions increased net sales by approximately 5.1% during fiscal 2022.
During fiscal 2022, we maintained a continued focus on our product-driven strategy, with an emphasis on innovation, design creativity, quality, and personalized customer service. The strength and flexibility of our global manufacturing and sourcing operations in the U.S., Canada, Haiti, Asia, and Turkey enabled us to support the evolving needs of our mattress fabrics and cover customers throughout the year. While we experienced lower demand in our mattress cover business, particularly during the second half of the year, we continue to believe our on-shore, near-shore, and off-shore supply chain strategy, as well as our fabric-to-cover model, remains a preferred platform for sewn mattress cover customers.
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Looking ahead, we continue to navigate a convergence of macroeconomic headwinds that are affecting consumer spending patterns. While we are optimistic about planned new programs and product development opportunities for fiscal 2023, industry weakness is expected to continue for some period of time, which may reduce demand for mattress fabric and cover products and delay the timing of new product rollouts. We expect these conditions are likely to continue pressuring results through at least the first half of fiscal 2023. Additionally, the continued impact of the COVID-19 pandemic and Russia’s invasion of Ukraine remain unknown and depend on factors beyond our knowledge or control. At this time, we cannot reasonably estimate the ongoing impact of the COVID-19 pandemic or the evolving impact of the Russia-Ukraine war on our mattress fabrics segment ; however, 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 2022, as compared to fiscal 2021, was primarily due to lower sales; operating inefficiencies at our U.S. and Canadian locations due to the rapid and material decline in revenues during the fourth quarter; higher freight, raw material, and labor costs; operating inefficiencies within our global platform due to an unfavorable product mix affecting our U.S. and Canadian locations; unfavorable foreign currency exchange rate fluctuations in China and Canada; and operating inefficiencies due to labor shortages in the U.S. and Canada.
Our previously implemented price increase and materials surcharge, as well as the selective price increase implemented during the third quarter and the targeted price increase on certain products implemented during the fourth quarter, have helped offset a portion of the current inflationary pressures. However, we expect the ongoing rise in labor, freight, and raw materials to continue pressuring profitability through at least the first half of fiscal 2023. We believe these headwinds will be mitigated to some extent by an additional targeted price increase on certain products that we are implementing during the second quarter of fiscal 2023, as well as our ongoing efforts to control our internal costs and improve efficiencies, but we will consider further reasonable pricing actions as necessary to mitigate and manage inflation.
CLASS International Holdings, Ltd.
Effective January 1, 2017, Culp International Holdings, Ltd. (“Culp International”), a wholly-owned subsidiary of the company, entered into a joint venture agreement pursuant to which Culp International owned 50% of CLASS International Holdings, Ltd. (“CIH”). CIH produces cut and sewn mattress covers and is housed in two facilities totaling 120,000 square feet, located in a modern industrial park on the northeastern border of Haiti. During the fourth quarter of fiscal 2021, Culp International acquired the remaining 50% ownership interest in CIH from its former joint venture partner, such that we are now the sole owner with full control of CIH. We believe having sole ownership of this operation increases our capacity and enhances our flexibility by having near-shore capabilities that help us meet the needs of our mattress cover customers.
See Note 2 of the consolidated financial statements for further details regarding this business combination.
Segment Assets
Segment assets consist of accounts receivable, inventory, property, plant, and equipment, and right of use assets.
(dollars in thousands)
May 1,
2022
May 2,
2021
% Change
Accounts receivable
$
9,865
$
20,427
(51.7
)%
Inventory
39,028
30,047
29.9
%
Property, plant & equipment
38,731
41,694
(7.1
)%
Right of use assets
3,469
4,278
(18.9
)%
Total mattress fabrics segment assets
$
91,093
$
96,446
(5.6
)%
Refer to Note 18 of the consolidated financial statements for disclosures regarding determination of our segment assets.
Accounts Receivable
As of May 1, 2022, accounts receivable decreased by $10.6 million, or 51.7%, compared with May 2, 2021. This decrease reflects a significant decline in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021. Net sales for the fourth quarter of fiscal 2022 were $29.8 million, a decline of $13.1 million, or 30.6%, compared with net sales of $42.9 million during the fourth quarter of fiscal 2021. In addition, this decrease in accounts receivable reflects improved cash collections during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021, as more customers took advantage of cash discounts during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021.
Days’ sales outstanding was 30 days for the fourth quarter of fiscal 2022, compared with 43 days for the fourth quarter of fiscal 2021.
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Inventory
As of May 1, 2022, inventory increased by $9.0 million, or 29.9%, compared with May 2, 2021. This increase in inventory represents higher raw material costs, as well as an increase in inventory purchases to protect against supply chain disruption and support our customers.
Inventory turns were 2.9 for the fourth quarter of fiscal 2022, compared with 4.2 for the fourth quarter of fiscal 2021.
Property, Plant, & Equipment
As of May 1, 2022, property, plant, and equipment decreased $3.0 million, or 7.1%, compared with May 2, 2021. This decrease mostly represents (i) depreciation expense totaling $6.2 million, partially offset by (ii) capital spending of $3.4 million associated with equipment to expand capacity at our operation located in Canada.
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. The $41.7 million as of May 2, 2021, represents property, plant, and equipment of $28.8 million, $12.0 million, and $855,000 located in the U.S., Canada, and Haiti, respectively.
Right of Use Assets
As of May 1, 2022, right of use assets decreased $809,000, or 18.9%, compared with May 2, 2021. This decrease mostly represents rent expense incurred during fiscal 2022 that related to executed lease agreements.
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. The $4.3 million as of May 2, 2021, represents right of use assets of $2.4 million, $1.4 million, and $400,000 located in Haiti, the U.S., and Canada, respectively.
Upholstery Fabrics Segment
Net Sales
Twelve Months Ended
(dollars in thousands)
May 1,
2022
May 2,
2021
% Change
Non-U.S. Produced
$
133,271
93
%
$
133,029
94
%
0.2
%
U.S. Produced
9,409
7
%
9,020
6
%
4.3
%
Total
$
142,680
100
%
$
142,049
100
%
0.4
%
Upholstery fabrics sales increased 0.4% in fiscal 2022 compared to the prior year.
The increase in upholstery fabrics net sales during fiscal 2022 reflects higher demand for our residential upholstery products primarily during the first quarter, as compared to the prior-year first quarter, which was negatively affected by disruption from the COVID-19 pandemic. This increase was partially offset by a significant drop in sales for residential upholstery fabric products during the fourth quarter due to COVID-related shutdowns of our facilities in China throughout the month of April and, to a lesser extent, a slowdown in new business for the residential home furnishings industry during the fourth quarter. It was also offset by lower sales in our residential business during the second quarter, primarily due to COVID-19 related shutdowns of our sourcing partners and customers in Vietnam, as well as lower sales for Read in our hospitality business during the first six months of fiscal 2022. The increase in net sales also reflects the impact of pricing and freight surcharge actions that were in effect during the year, including a price increase that was effective throughout the year on products sold in the U.S. to help offset unfavorable foreign currency exchange rate fluctuations associated with our operations in China; a freight surcharge implemented during the second quarter; and an additional price increase implemented on new orders beginning in the third quarter. Together, these price increases and freight surcharge accounted for approximately 2.9% of net sales during fiscal 2022.
Throughout the year, we maintained our sustained focus on product innovation, including our popular portfolio of LiveSmart® performance products. Our hospitality business continued to recover from pandemic-related impacts, with higher sales in both our hospitality/contract fabric business and our Read business during the second half of the year. We also commenced operations at our new Haiti cut and sew facility during the third quarter, and we continued the ramp up in production at this facility during the fourth quarter.
Looking ahead, while the shutdowns that significantly curtailed our China operations throughout April and May have now been lifted, lingering constraints from the shutdowns may continue to affect us during the first quarter of fiscal 2023. We also expect the slowdown in new retail business for the residential home furnishings industry may affect demand for our residential business for some
33
period of time . Despite these challenges, we believe our business is well positioned for the long-term with our product-driven strategy and innovative product offerings, as well as our flexible Asian platform, our long-term supplier relationships, and our expanded capacity in Haiti.
Notably, the ongoing economic and health effects of the COVID-19 pandemic, as well as the impact of Russia’s invasion of Ukraine, including its effect on petrochemical pricing and consumer spending, remain unknown and depend on factors beyond our control. At this time, we cannot reasonably estimate the impact, but we note that if conditions worsen in either of these situations, the impact on our suppliers, consumers, and/or the global economy could adversely affect our operations and financial performance.
Gross Profit and Operating Income
Twelve Months Ended
(dollars in thousands)
May 1,
2022
May 2,
2021
Change
Gross profit
$
19,635
$
25,968
(24.4
)%
Gross profit margin
13.8
%
18.3
%
(450
) bp
Selling, general and administrative expenses
14,009
14,092
(0.6
)%
Income from operations
5,626
11,876
(52.6
)%
Operating margin
3.9
%
8.4
%
(450
) bp
The decrease in upholstery fabrics profitability was primarily due to higher freight and material costs; start-up costs at our new Haiti cut and sew facility; unfavorable foreign currency fluctuations in China; a lower contribution from our Read business; and additional employee training costs and operating inefficiencies at the new Haiti cut and sew facility during the fourth quarter as it continued to scale capacity to its full planned output level.
Looking ahead, we expect current inflationary pressures, as well as labor availability in our U.S. operations, may continue to pressure our profitability to some extent, but the pricing actions implemented throughout the year have helped offset foreign currency exchange rate fluctuations and rising freight and material costs, as intended. This was especially true during the fourth quarter, with the full realization of the additional price increase that was in effect for new orders during the quarter. We also expect profitability will be affected over the near-term by additional employee training costs and operating inefficiencies at our new Haiti cut and sew facility as we continue to increase our labor force in order to ramp up production to meet customer demand.
Segment Assets
Segment assets consist of accounts receivable, inventory, property, plant, and equipment, and right of use assets.
(dollars in thousands)
May 1,
2022
May 2,
2021
% Change
Accounts receivable
$
12,361
$
17,299
(28.5
)%
Inventory
27,529
25,870
6.4
%
Property, plant & equipment
2,030
1,495
35.8
%
Right of use assets
8,124
5,945
36.7
%
$
50,044
$
50,609
(1.1
)%
Accounts Receivable
As of May 1, 2022, accounts receivable decreased by $4.9 million, or 28.5%, compared with May 2, 2021. This decrease reflects a significant decline in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021. Net sales for the fourth quarter of fiscal 2022 were $27.2 million, a decline of $8.9 million, or 24.8%, compared with net sales of $36.1 million during the fourth quarter of fiscal 2021.
Days’ sales outstanding was 40 days for the fourth quarter of fiscal 2022, compared with 42 days for the fourth quarter of fiscal 2021.
Inventory
As of May 1, 2022, inventory increased $1.7 million, or 6.4%, compared with May 2, 2021.This increase in inventory is primarily due to higher material costs. Inventory purchases and shipments of inventory were minimal during April 2022 due to the COVID-19 related shutdowns that affected our China operations throughout the month.
Inventory turns were 3.0 during the fourth quarter of fiscal 2022, compared with 4.6 for the fourth quarter of fiscal 2021.
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Property, Plant , & Equipment
As of May 1, 2022, property, plant, and equipment increased by $535,000, or 35.8%, compared with May 2, 2021. This increase mostly represents (i) capital spending of $1.0 million that was primarily associated with the start-up of our upholstery cut and sew operation located in Haiti, partially offset by (ii) depreciation expense totaling $794,000.
The $2.0 million as of May 1, 2022, represents property, plant, and equipment of $1.0 million, $756,000, and $255,00 located in the U.S., Haiti, and China, respectively. The $1.5 million as of May 2, 2021, represents property, plant, and equipment of $1.1 million and $420,000 located in the U.S. and China, respectively.
Right of Use Assets
As of May 1, 2022, our right of use assets increased by $2.2 million, or 36.7%, compared with May 2, 2021. This increase mostly represents the commencement of our agreement to lease a 90,000 square foot facility located in Haiti. This facility is dedicated to the production of cut and sewn upholstery kits. The lease agreement commenced during the third quarter of fiscal 2022, has an initial lease term of eight years, and required rent payments totaling $2.8 million that were paid in advance of the commencement of the lease.
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. The $5.9 million as of May 2, 2021, represents right of use assets of $5.0 million and $952,000 located in China and the U.S., respectively.
Other Income Statement Categories
Twelve Months Ended
(dollars in thousands)
May 1,
2022
May 2,
2021
% Change
Selling, general, and administrative expenses
$
35,415
$
37,756
(6.2
)%
Interest expense
17
51
(66.7
)%
Interest income
373
244
52.9
%
Gain on bargain purchase
—
819
(100.0
)%
Other expense
1,359
2,208
(38.5
)%
Selling, General, and Administrative Expenses
The decrease in selling, general, and administrative expenses during fiscal 2022, as compared with fiscal 2021, is mostly due to lower incentive compensation expense, which includes annual bonuses and stock-based compensation, reflecting unfavorable financial results in relation to pre-established performance targets.
Interest Expense
Interest expense incurred during fiscal 2022 and 2021 reflects our historically low level and short duration of borrowings outstanding.
Interest Income
Interest income in fiscal 2022 and fiscal 2021 mostly reflects investment income earned on our current investments of excess cash held in (i) money market funds, (ii) bond, other fixed income, and equity-related mutual funds, and (iii) investment-grade U.S. corporate, foreign, and government bonds, as well as (iv) a money market fund and equity related mutual fund investments associated with our rabbi trust that funds our deferred compensation plan.
Interest income is expected to decline during fiscal 2023 primarily due to the liquidation of all of our short-term investments classified as available-for-sale and corporate bonds classified as held-to-maturity during the fourth quarter of fiscal 2022.
Gain on Bargain Purchase
Effective February 1, 2021, Culp International, a wholly-owned subsidiary of the company, acquired the remaining 50% ownership interest in CIH from its former joint venture partner. Pursuant to this transaction, we are now the sole owner with full control over CIH. The gain from bargain purchase represents the net assets acquired from this transaction that exceeded the fair value of our previously held 50% ownership interest of $1.7 million and the $954,000 total purchase price for the remaining 50% ownership interest.
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See Note 2 of the consolidated financial statements for further details.
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.
The decrease in other expense during fiscal 2022, as compared with fiscal 2021, is due mostly 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 2022, we reported foreign exchange rate losses associated with our China operations of $104,000, a decrease of $1.3 million as compared to $1.4 million in foreign exchange rate losses reported during fiscal 2021. This decrease of $1.3 million was partially offset by a $450,000 realized loss 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 2021.
The significant $1.4 million foreign exchange rate loss incurred during fiscal 2021, which was mostly non-cash, was mostly offset by $1.3 million in income tax benefits, which reduced our income tax payments. These income tax benefits were associated with income tax deductible foreign exchange rate losses based on more unfavorable 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 losses incurred on our U.S. dollar denominated balance sheet accounts associated with our operations located in China are income tax deductible, 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 $2.9 million, or (888.0%) of loss before income taxes, during fiscal 2022, compared with income tax expense of $7.7 million, or 70.7% of income before income taxes, during fiscal 2021.
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:
2022
2021
U.S. federal income tax rate
21.0
%
21.0
%
valuation allowance
(56.3
)
78.4
income tax effects of the 2017 Tax Cuts and Jobs Act
—
(33.8
)
global intangible low taxed income tax (GILTI)
(540.9
)
—
foreign tax rate differential
(206.2
)
10.9
income tax effects of Chinese foreign exchange gains and losses
(20.6
)
(8.4
)
withholding taxes associated with foreign tax jurisdictions
(172.8
)
7.7
uncertain income tax positions
105.4
1.6
U.S. state income taxes
21.5
0.3
stock-based compensation
(3.3
)
0.3
gain on bargain purchase
—
(1.6
)
other (2)
(35.8
)
(5.7
)
Consolidated effective income tax rate (1)
(888.0
)%
70.7
%
(1)
Our consolidated effective income tax rates for all fiscal years presented were negatively affected by the mix of consolidated (loss) income before income taxes, as significant pre-tax losses have been incurred by our U.S. operations and almost all of our taxable income was earned by our foreign operations located in China and Canada, which have higher income tax rates than the U.S. As a result, income tax expense incurred stems from taxable income from our foreign jurisdictions that exceeds our consolidated (loss) income before income taxes. Accordingly, the extent of the fluctuations in our consolidated effective income tax rates is dependent on the extent to which income tax expense incurred from our foreign operations compares with consolidated (loss) income before income taxes, which has been significantly lowered by our U.S. operations.
(2)
“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 2021
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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%). In addition, the enactment of the new regulations and the provisions for the GILTI High-Tax exception were retroactive to the original enactment of the GILTI tax provision, which included our 2019 and 2020 fiscal years.
Since we met the requirements for the GILTI High-Tax exception for our 2019 and 2020 fiscal years, we recorded a non-cash income tax benefit of $3.6 million resulting from the re-establishment of certain U.S. federal net operating loss carryforwards. This $3.6 million income tax benefit was recorded as a discrete event in which its full income tax effects were recorded during the first quarter of fiscal 2021.
Fiscal 2022
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 do not expect to 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, are eligible for a significant amount of deductible accelerated depreciation. As a result, our current year’s income tax expense is much lower than prior fiscal years, and therefore, our current effective income tax rate is expected to be 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 in an economic zone that permits a 0% income tax rate for the first fifteen years of operations, for which we have ten years remaining. Since our operations located in Haiti are not subject to income tax, our projected current effective income tax rate of 0% will be 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 did not incur any GILTI tax for the 2022 tax year, as the losses subject to GILTI tax from our Haitian operations exceeded the income subject to GILTI tax from our Canadian operation.
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 a result of the U.S. tax law change relating to the GILTI tax provisions of the TCJA, we assessed the need for an additional valuation allowance against our U.S. net deferred income taxes as of the end of the first quarter of fiscal 2021. GILTI represented a significant source of our U.S. taxable income during fiscal 2019 and 2020 that offset our U.S. pre-tax losses during such years, and which offset was reversed because of the retroactivity of the new GILTI regulations. Consequently, due to the retroactivity of the new regulations, we experienced a recent history of cumulative U.S. taxable losses during the last two fiscal years, and we expected at the time of this assessment that our history of U.S. pre-tax losses would continue into fiscal 2021. As a result of the significant weight of this negative evidence, we believed that it was more-likely-than-not that our U.S. deferred income taxes would not be fully realizable. Accordingly, we recorded a non-cash income tax charge of $7.0 million to provide for a full valuation allowance against our U.S. net deferred income tax assets. This $7.0 million income tax charge was recorded as a discrete event in which its full income tax effects were recorded during the first quarter of fiscal 2021.
As of May 1, 2022, 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. taxable losses, in that we experienced U.S. taxable losses during each of the last three fiscal years. In addition, we are currently expecting U.S. taxable losses to continue into fiscal 2023. 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 $11.9 million as of May 1, 2022.
Refer to Note 12 of the consolidated financial statements for additional disclosures regarding the valuation allowance against our U.S. net deferred income taxes.
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Deferred Income Taxes – Undistributed Earnings from Foreign Subsidiaries
We assess (i) whether the undistributed earnings from our foreign subsidiaries will be reinvested indefinitely or eventually distributed to our U.S. parent company, and (ii) if we are required to a record a deferred income tax liability for undistributed earnings from foreign subsidiaries that will not be reinvested indefinitely. As of May 1, 2022, 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 May 1, 2022, we recorded a deferred income tax liability associated with our undistributed earnings from foreign subsidiaries of $3.6 million.
Refer to Note 12 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, 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 May 1, 2022, we had a $1.1 million total gross unrecognized income tax benefit that 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 2018 and subsequent. Canadian provincial (Quebec) income tax returns filed by us remain subject to examination for income tax years 2018 and subsequent. Income tax returns associated with our operations located in China are subject to examination for income tax year 2017 and subsequent.
Refer to Note 12 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 (refunded) by jurisdiction:
(dollars in thousands)
2022
2021
United States Federal - Alternative Minimum Tax
(AMT) credit refunds (1)
$
—
$
(1,510
)
United States Federal - transition tax
266
226
China - Income Taxes
2,036
2,076
China - Withholding Taxes Associated with Earnings
and Profits Distribution to U.S. Parent
487
798
Canada - Income Taxes
311
1,408
$
3,100
$
2,998
(1)
In accordance with the provisions of the TCJA, we elected to treat our prior AMT credit carryforward balance of $1.5 million as refundable. We received refunds totaling $1.5 million in two separate installments totaling $746,000 and $764,000 during the first and second quarters of fiscal 2021, respectively.
Future Liquidity
We are currently projecting annual cash income tax payments of approximately $3.2 million for fiscal 2023, compared with $3.1 million and $3.0 million for fiscal 2022 and 2021, respectively. Our estimated cash income tax payments for fiscal 2023 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, and the timing of when significant capital projects will be placed into service, which determines the deductibility of accelerated depreciation.
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Additionally, we currently do not expect to incur any income taxes in the U.S. on a cash basis during fiscal 2023 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 2023 - $264,000; FY 2024 - $499,000; FY 2025- $665,000; and FY 2026 - $831,000.
2021 compared with 2020
For a comparison of our results of operations for the fiscal years ended May 2, 2021, and May 3, 2020, 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 2, 2021, filed with the SEC on July 16, 2021.
Liquidity and Capital Resources
Overall
Currently, our sources of liquidity include cash and cash equivalents, cash flow from operations, and amounts available under our revolving credit lines. These sources have been adequate for day-to-day operations, capital expenditures, debt payments, common stock repurchases, and dividend payments. We believe our cash and cash equivalents of $14.6 million as of May 1, 2022, cash flow from operations, and the current availability under our revolving credit lines will be sufficient to fund our foreseeable business needs, commitments, and contractual obligations.
As of May 1, 2022, our cash and cash equivalents, short-term investments (available for sale), and short-term and long-term investments (held-to-maturity) (collectively “cash and investments’) totaled $14.6 million compared with $46.9 million as of May 2, 2021.
The decrease in our cash and investments from the end of fiscal 2021 was mostly due to (i) $5.7 million of capital expenditures primarily related to equipment associated with our mattress fabrics segment, our innovation campus located in downtown High Point, NC, and new equipment associated with information technology, (ii) cash payments totaling $5.5 million for regular quarterly dividend payments to shareholders, (iii) common stock repurchases totaling $1.8 million, (iv) $1.1 million of contributions to our rabbi trust that funds our deferred compensation plan, and (v) net cash used in operating activities totaling $17.4 million.
Our net cash used in operating activities was $17.4 million during fiscal 2022, compared with net cash provided by operating activities of $21.5 million during fiscal 2021. This difference was due mostly to (i) a net increase in cash that was generated during fiscal 2021 due to a significant surge in customer demand as a result of the focus-on-the-home trend that occurred as businesses began to re-open coming out of pandemic-related closures, which such surge did not recur during fiscal 2022; (ii) a decrease in accounts payable due to the significant decrease in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021, as noted above, and due to our return to normal credit terms with our vendors, as opposed to the extended terms previously granted in response to the COVID-19 pandemic; (iii) an increase in inventory due to higher material costs, as well as an increase in inventory purchases to protect against supply chain disruption and support our customers; (iv) a decrease in accrued expenses primarily due to annual incentive bonus compensation paid during the first quarter of fiscal 2022; (v) $1.9 million in payments for the new building lease and start-up expenses associated with our upholstery fabrics cut and sew operation located in Haiti; partially offset by (vi) a decrease in accounts receivable related to the decrease in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021, as noted above, and due to our customers’ return to normal credit terms, rather than the extended terms previously granted in response to the COVIVD-19 pandemic.
As of May 1, 2022, 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.
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Our cash and cash equivalents may be adversely affected by factors beyond our control, such as ( i ) recent 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 inventory purchases to protect against supply chain disruptions and inflation.
By Geographic Area
A summary of our cash and investments by geographic area follows:
May 1,
May 2,
(dollars in thousands)
2022
2021
United States
$
4,430
$
34,465
China
9,502
10,635
Canada
267
1,525
Haiti
341
220
Cayman Islands
10
8
$
14,550
$
46,853
Dividend Program
On June 29, 2022, our board of directors announced the decision to suspend the company’s quarterly cash dividend. Considering the current and expected macroeconomic conditions, we believe that preserving capital and managing liquidity is in the company’s best interest to support future growth and the long-term interests of our shareholders.
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.
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 and timing of share purchases are based on working capital requirements, market and general business conditions, and other factors, including alternative investment opportunities.
During fiscal 2022, we repurchased 121,688 shares of our common stock at a cost of $1.8 million. As a result, as of May 1, 2022, $3.2 million is 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 2023.
During fiscal 2021, we did not repurchase any shares of common stock.
Working Capital
Operating Working Capital
Operating working capital (accounts receivable and inventories, less deferred revenue, accounts payable-trade, and capital expenditures) was $67.7 million as of May 1, 2022, compared with $50.2 million as of May 2, 2021. Operating working capital turnover was 5.2 during the fourth quarter of fiscal 2022 compared with 6.4 during the fourth quarter fiscal 2021.
Accounts Receivable
Accounts receivable as of May 1, 2022, were $22.2 million, a decrease of $15.5 million, or 41.1%, compared with $37.7 million as of May 2, 2021. This decrease reflects a significant decline in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021. Net sales for the fourth quarter of fiscal 2022 were $56.9 million, a decline of $22.1 million, or 28.0%, compared with net sales of $79.1 million during the fourth quarter of fiscal 2021. In addition, the decrease in accounts receivable reflects improved cash collections during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021, as more customers associated with our mattress fabrics segment took advantage of cash discounts during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021.
Days’ sales outstanding was 35 days for the fourth quarter of fiscal 2022, as compared with 43 days for the fourth quarter of fiscal 2021.
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Inventory
Inventories as of May 1, 2022, were $66.6 million, an increase of $10.6 million, or 19.0%, compared with $55.9 million as of May 2, 2021. This increase is primarily associated with our mattress fabrics segment and represents higher raw material costs, as well as an increase in inventory purchases to protect against supply chain disruption and support our customers.
Accounts Payable
Accounts payable - trade was $20.1 million as of May 1, 2022, a decrease of $22.4 million, or 52.8%, compared with $42.5 million as of May 2, 2021. This decrease in accounts payable - trade represents a decline in accounts payable due to the significant decrease in net sales during the fourth quarter of fiscal 2022 compared with the fourth quarter of fiscal 2021. It also reflects our return to normal credit terms with our vendors, as opposed to the extended terms previously granted in response to the COVID-19 pandemic.
Financing Arrangements, Commitments and Contingencies, and Contractual Obligations
The Company has adopted the amendment to Item 303 of Regulation S-K and, accordingly, is no longer required to provide a contractual obligation table. However, please refer to the descriptions of our financing arrangements, commitments and contingencies, and contractual obligations outlined below and the applicable Note references to our consolidated financial statements noted below for disclosure of the cash requirements associated with these items.
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 May 1, 2022, 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 May 1, 2022, we were in compliance with these financial covenants.
Refer to Note 11 of the consolidated financial statements for further disclosure regarding our revolving credit agreements.
Leases
Refer to Note 13 of the consolidated financial statements for disclosure of our lease obligations, which includes a five-year maturity schedule.
Capital Expenditures
As of May 1, 2022, and May 2, 2021, we had total amounts due regarding capital expenditures totaling $473,000 and $348,000, respectively, which pertained to outstanding vendor invoices, none of which were financed.
Uncertain Income Tax Positions
As of May 1, 2022, we had $1.1 million of total gross unrecognized tax benefits, which primarily relate to double taxation under applicable income tax treaties with foreign tax jurisdictions. T he 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 were $5.7 million during fiscal 2022, compared with $6.7 million during fiscal 2021. Capital expenditures for fiscal 2022 primarily related to equipment associated with our mattress fabrics segment, our innovation campus located in downtown High Point, NC, and new equipment associated with information technology. Capital expenditures for fiscal 2021 mostly related to our mattress fabrics segment.
Depreciation expense was $7.0 million during fiscal 2022, compared with $6.8 million during fiscal 2021. Depreciation expense for fiscal 2022 and 2021 mostly related to our mattress fabrics segment.
For fiscal 2023, cash capital expenditures are expected to focus primarily on critical maintenance level capital spending centered on our mattress fabrics segment. Funding for capital expenditures is expected to be primarily from cash provided by operating activities.
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Handling Costs
We record warehousing costs in SG&A expenses. These costs were $4.3 million during fiscal 2022 and $3.9 million during fiscal 2021. 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 $31.8 million, or 10.8% of net sales, during fiscal 2022, and $45.9 million, or 15.3% of net sales, during fiscal 2021.
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.
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 May 1, 2022, 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 in each product 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.
As of May 1, 2022, and May 2, 2021, the reserve for inventory markdowns was $7.3 million and $6.1 million, respectively.
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 May 1, 2022, we recorded a full valuation allowance against all our U.S. net deferred income tax assets totaling $11.9 million.
Refer to Note 12 of the consolidated financial statements for additional disclosures regarding our assessments and conclusions reached regarding our valuation allowance as of May 1, 2022.
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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 $1.1 million, $1.3 million, and $614,000 of compensation expense within selling, general, and administrative expense for our equity-based awards in fiscal 2022, 2021, and 2020, respectively.
Adoption of New Accounting Pronouncements
Refer to Note 1 of the consolidated financial statements for recently adopted accounting pronouncements for fiscal 2022.
Recently Issued Accounting Standards
Refer to Note 1 of the consolidated financial statements for recently issued accounting pronouncements for fiscal 2023 and beyond.