Crown Crafts Inc: Form 10-Q for the period ended Oct 2, 2022

FORWARD-LOOKING INFORMATION

Certain of the statements made in this Quarterly Report on Form 10-Q (this “Quarterly Report”) within this Item 2. and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to the protections of, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995. Such statements are based upon management’s current expectations, projections, estimates and assumptions. Words such as “expects,” “believes,” “anticipates,” “intends,” “may,” “will,” “could,” “would” and variations of such words and similar expressions may identify such forward-looking statements. Forward-looking statements involve known and unknown risks and uncertainties that may cause future results to differ materially from those suggested by the forward-looking statements. These risks include, among others, the impact of the COVID-19 pandemic on the Company’s business operations, general economic conditions, including changes in interest rates, in the overall level of consumer spending and in the price of oil, cotton and other raw materials used in the Company’s products, changing competition, changes in the retail environment, the Company’s ability to successfully integrate newly acquired businesses, the level and pricing of future orders from the Company’s customers, the Company’s dependence upon third-party suppliers, including some located in foreign countries with unstable political situations, the Company’s ability to successfully implement new information technologies, customer acceptance of both new designs and newly-introduced product lines, actions of competitors that may impact the Company’s business, disruptions to transportation systems or shipping lanes used by the Company or its suppliers, and the Company’s dependence upon licenses from third parties. Reference is also made to the Company’s periodic filings with the Securities and Exchange Commission for additional factors that may impact the Company’s results of operations and financial condition. The Company does not undertake to update the forward-looking statements contained herein to conform to actual results or changes in the Company’s expectations, whether as a result of new information, future events or otherwise.

DESCRIPTION OF BUSINESS

The Company was originally formed as a Georgia corporation in 1957 and was reincorporated as a Delaware corporation in 2003. The Company operates indirectly through two of its wholly-owned subsidiaries, NoJo Baby & Kids, Inc. and Sassy Baby, Inc., in the infant, toddler and juvenile products segment within the consumer products industry. The infant, toddler and juvenile products segment consists of infant and toddler bedding and blankets, bibs, disposables, toys and feeding products. The Company’s products are marketed under Company-owned trademarks, under trademarks licensed from others and as private label goods. Sales of the Company’s products are made directly to retailers, such as mass merchants, large chain stores, juvenile specialty stores, value channel stores, grocery and drug stores, restaurants, wholesale clubs and internet-based retailers.

The accompanying unaudited condensed consolidated statements of income for the three- and six-month periods ended September 26, 2021 include income, expenses and losses associated with the operating activities of Carousel, a wholly-owned subsidiary that manufactured and marketed infant and toddler bedding directly to consumers online from a facility in Douglasville, Georgia. On May 5, 2021, the Board approved the closure of Carousel due to a history of high costs, declining sales and operating and cash flow losses, as well as management’s determination that such losses were likely to continue. Accordingly, the operations of Carousel ceased at the close of business on May 21, 2021.

Foreign and domestic contract manufacturers produce most of the Company’s products, with the largest concentration being in China. The Company makes sourcing decisions based on quality, timeliness of delivery and price, including the impact of ocean freight and duties. Although the Company maintains relationships with a limited number of suppliers, the Company believes that its products may be readily manufactured by several alternative sources in quantities sufficient to meet the Company's requirements.

A summary of certain factors that management considers important in reviewing the Company’s results of operations, financial position, liquidity and capital resources is set forth below, which should be read in conjunction with the accompanying condensed consolidated financial statements and related notes included in the preceding sections of this Quarterly Report.

RESULTS OF OPERATIONS

The following table contains the results of operations for the three- and six-month periods ended October 2, 2022 and September 26, 2021 and the dollar and percentage changes for those periods (in thousands, except percentages):

Net Sales: Sales decreased to $18.7 million for the three months ended October 2, 2022, compared with $20.2 million for the three months ended September 26, 2021, a decrease of $1.5 million, or 7.4%. Sales of bedding, blankets and accessories decreased by $1.6 million, which was offset by an increase in sales of bibs, toys and disposable products of $104,000. Sales decreased to $34.4 million for the six months ended October 2, 2022, compared with $38.9 million for the six months ended September 26, 2021, a decrease of $4.5 million, or 11.5%. Sales of bedding, blankets and accessories decreased by $4.1 million, and sales of bibs, toys and disposable products decreased by $439,000. The decreases in sales are primarily due to lower replenishment orders at retailers. Also, during the current-year periods, the Company’s customers began to reduce their purchases as their inventories increased, which the Company believes resulted from customers’ excessive inventory purchases during the first quarter of calendar 2022 and consumers’ response to macroeconomic conditions.

Gross Profit: Gross profit decreased by $622,000 and decreased from 30.0% of net sales for the three-month period ended September 26, 2021 to 29.1% of net sales for the three-month period ended October 2, 2022. Gross profit decreased by $125,000 but increased from 27.5% of net sales for the six-month period ended September 26, 2021 to 30.8% of net sales for the six-month period ended October 2, 2022. The decrease in the gross profit amount is net of the positive impact of the closure of Carousel, which in the prior-year period recognized a gross loss of $688,000, including losses from the sale of inventory below cost and the recognition of charges of $334,000 associated with the settlement with a supplier of a commitment to purchase fabric and $265,000 associated with the liquidation of Carousel’s remaining inventory upon the closure of the business. Although the gross profit in the prior-year period was impacted by increases in costs across the entire supply chain, the Company in the current-year has realized some stabilization in its input costs. Finally, the Company also expects to benefit in future periods from recent increases in the selling prices of its products.

Marketing and Administrative Expenses: Marketing and administrative expenses decreased by $428,000, and decreased from 15.6% of net sales for the three-month period ended September 26, 2021 to 14.6% of net sales for the three-month period ended October 2, 2022. The prior-year period included $85,000 for charges incurred by Carousel. Marketing and administrative expenses decreased by $381,000 but increased from 16.8% of net sales for the six-month period ended September 26, 2021 to 17.9% of net sales for the six-month period ended October 2, 2022. The prior-year period included $495,000 for charges incurred by Carousel.

Gain on extinguishment of debt: On May 20, 2021, the PPP Loan was forgiven in full, which resulted in a gain on extinguishment of debt in the amount of $1,985,000 during the three months ended June 27, 2021 and the six months ended September 26, 2021.

Income Tax Expense: The Company’s provision for income taxes is based upon an estimated annual effective tax rate (“ETR”) from continuing operations of 23.5% for the six-month period ended October 2, 2022, as compared with an estimated annual ETR from continuing operations of 19.6% for the six-month period ended September 26, 2021. The gain on extinguishment of debt associated with the forgiveness of the PPP Loan was permitted to be excluded from taxable income, the effect of which lowered the ETR for the prior-year period by approximately four percentage points.

As a result of the consideration of the relevant information regarding the state portion of its income tax provision, the Company recorded discrete reserves for unrecognized tax liabilities of $27,000 and $22,000 during the three-month periods ended October 2, 2022 and September 26, 2021, respectively, and $46,000 and $45,000 during the six-month periods ended October 2, 2022 and September 26, 2021, respectively, in the accompanying unaudited condensed consolidated statements of income. The Company also recorded discrete income tax charges of $5,000 and $6,000 during the three- and six-month periods ended October 2, 2022, respectively, and the Company recorded discrete income tax benefits of $28,000 and $72,000 during the three- and six-month periods ended September 26, 2021, respectively, to reflect the net effects of the excess tax benefits and tax shortfalls arising from the exercise of stock options and the vesting of non-vested stock during the periods.

The ETR on continuing operations and the discrete income tax charges and benefits set forth above resulted in an overall provision for income taxes of 24.7% and 19.2% for the six-month periods ended October 2, 2022 and September 26, 2021, respectively.

Although the Company does not anticipate a material change to the ETR from continuing operations for the remainder of fiscal year 2023, several factors could impact the ETR, including variations from the Company’s estimates of the amount and source of its pre-tax income, and the actual ETR for the year could differ materially from the Company’s estimates.

FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities decreased from $3.2 million for the six-month period ended September 26, 2021 to $2.7 million for the six-month period ended October 2, 2022. The decrease in the current year was the result of an increase in inventory in the current year that was $3.2 million higher than the increase in the prior year and a $1.6 million decrease in net income from the prior year to the current year. There was also an increase in accounts payable in the current year that was $1.6 million lower than the increase in the prior year. There was a decrease in accrued liabilities in the current year that was $619,000 lower than the decrease in the prior year. These decreases were offset by a decrease in accounts receivable in the current year that was $4.8 million higher than the decrease in the prior year and the gain on extinguishment of debt of $1,985,000 in the prior year that was associated with the forgiveness of the PPP Loan.

Net cash used in investing activities, which were primarily associated with capital expenditures for property, plant and equipment, decreased from $253,000 in the prior year to $191,000 in the current year.

Net cash used in financing activities, which were primarily associated with the payment of dividends, increased by $73,000 from the prior year to the current year.

As of October 2, 2022, there was no balance owed on the Company’s revolving line of credit with CIT, there was no letter of credit outstanding and $26.0 million was available under the revolving line of credit based on the Company’s eligible accounts receivable and inventory balances.

To reduce its exposure to credit losses and to enhance the predictability of its cash flow, the Company assigns substantially all of its trade accounts receivable to CIT under factoring agreements. Under the terms of the factoring agreements, CIT remits customer payments to the Company as such payments are received by CIT. As such, the Company does not take advances on the factoring agreements.

CIT bears credit losses with respect to assigned accounts receivable from approved customers that are within approved credit limits, while the Company bears the responsibility for adjustments from customers related to returns, allowances, claims and discounts. CIT may at any time terminate or limit its approval of shipments to a particular customer. If such a termination or limitation were to occur, then the Company must choose to either assume the credit risk for shipments after the date of such termination or limitation or discontinue shipments to the customer. Factoring fees, which are included in marketing and administrative expenses in the accompanying unaudited condensed consolidated statements of income, amounted to $79,000 and $85,000 for the three-month periods ended October 2, 2022 and September 26, 2021, respectively, and amounted to $147,000 and $149,000 for the six-month periods ended October 2, 2022 and September 26, 2021, respectively.

The Company continues to monitor the impact of the COVID-19 pandemic on its supply chain, manufacturing and distribution operations, customers and employees, as well as the U.S. economy in general. However, due to the uncertainty as to the duration and widespread nature of the COVID-19 pandemic, the success rates of vaccines for COVID-19 and the variants thereof, and the extent to which the vaccines are accepted and effectively administered, the Company cannot currently predict the long-term impact of the COVID-19 pandemic on its operations and financial results.

The uncertainties associated with the COVID-19 pandemic include potential adverse effects on the overall economy, the Company’s supply chain, transportation services, employees and customers, consumer sentiment in general, and traffic within the retail stores that carry the Company’s products. The COVID-19 pandemic could adversely affect the Company’s revenues, earnings, liquidity and cash flows and may require significant actions in response, including employee furloughs, closings of Company facilities, expense reductions or discounts of the pricing of the Company’s products, all in an effort to mitigate such effects.

Conditions surrounding COVID-19 change rapidly, and additional impacts of which the Company is not currently aware may arise. Based on past performance and current expectations, the Company believes that its anticipated cash flow from operations and the availability under its revolving line of credit are sufficient to fund the Company’s requirements for working capital and capital expenditures for at least the next 12 months.

The Company’s future performance is, to a certain extent, subject to general economic, financial, competitive, legislative, regulatory and other factors beyond its control. Based upon the current level of operations, the Company believes that its cash flow from operations and funds available under the revolving line of credit will be adequate to meet its liquidity needs.

For a discussion of market risks that could affect the Company, refer to the risk factors disclosed in Item 1A. of Part 1 of the Company’s Annual Report on Form 10-K for the year ended April 3, 2022.

INTEREST RATE RISK

Although the Company could have an exposure to interest rate risk related to its floating rate debt, there was no balance outstanding on its floating rate debt as of October 2, 2022.

COMMODITY RATE RISK

The Company sources its products primarily from foreign contract manufacturers, with the largest concentration being in China. The Company’s exposure to commodity price risk primarily relates to changes in the prices in China of cotton, oil and labor, which are the principal inputs used in a substantial number of the Company’s products. In addition, although the Company pays its Chinese suppliers in U.S. dollars, a strengthening of the rate of the Chinese currency versus the U.S. dollar could result in an increase in the cost of the Company’s finished goods. There is no assurance that the Company could timely respond to such increases by proportionately increasing the prices at which its products are sold to the Company’s customers.

MARKET CONCENTRATION RISK

The Company’s financial results are closely tied to sales to its top two customers, which represented approximately 73% of the Company’s gross sales in fiscal year 2022. In addition, 40% of the Company’s gross sales in fiscal year 2022 consisted of licensed products, which included 33% of sales associated with the Company’s license agreements with affiliated companies of the Walt Disney Company. The Company’s results could be materially impacted by the loss of one or more of these licenses.

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report, as required by paragraph (b) of Rules 13a-15 or 15d-15 of the Exchange Act. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this Quarterly Report, the Company’s disclosure controls and procedures are effective.

During the three-month period ended October 2, 2022, there were no changes in the Company’s internal control over financial reporting (“ICFR”) identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 of the Exchange Act that has materially affected, or is reasonably likely to materially affect, the Company’s ICFR.

There have been no material changes to the risk factors disclosed in Item 1A of Part 1 of the Company’s Annual Report on Form 10-K for the year ended April 3, 2022.