ITEM 1. Business
Description of Business
The Company was incorporated as a Georgia corporation in 1957 and was reincorporated as a Delaware corporation in 2003. The Company’s executive offices are located at 916 South Burnside Avenue, Suite 300, Gonzales, Louisiana 70737, its telephone number is (225) 647-9100 and its internet address is www.crowncrafts.com.
The Company operates indirectly through its wholly-owned subsidiaries, Sassy Baby, Inc. (formerly known as Hamco, Inc.) (“Sassy”), NoJo Baby & Kids, Inc. (formerly known as Crown Crafts Infant Products, Inc.) (“NoJo”) and Carousel Designs, LLC (“Carousel”), 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, soft bath products, disposable products, developmental toys and accessories. Sales of the Company’s products are generally made directly to retailers, such as mass merchants, large chain stores, mid-tier retailers, juvenile specialty stores, value channel stores, grocery and drug stores, restaurants, wholesale clubs and internet-based retailers, as well as directly to consumers through www.babybedding.com. The Company’s products are marketed under a variety of Company-owned trademarks, under trademarks licensed from others and as private label goods.
The Company's fiscal year ends on the Sunday nearest to or on March 31. References to “fiscal year 2020” or “2020” represent the 52-week period ended March 29, 2020 and “fiscal year 2019” or “2019” represent the 52-week period ended March 31, 2019.
The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge on its website at www.crowncrafts.com as soon as reasonably practicable after such material has been electronically filed with the SEC. These reports are also available without charge on the SEC’s website at www.sec.gov.
International Sales
Sales to customers in countries other than the U.S. represented 6% and 4% of the Company’s total gross sales during fiscal years 2020 and 2019, respectively, which included 2% of sales to the customers set forth below that represented at least 10% of the Company’s gross sales during fiscal year 2020. International sales are based upon the location that predominately represents what the Company believes to be the final destination of the products delivered to the Company’s customers.
Company Response to COVID-19
In late January 2020, the Company began to monitor the global effects of “COVID-19,” an infectious disease caused by Severe Acute Respiratory Syndrome Coronavirus 2 (SARS CoV-2) that was first detected in November 2019 in the city of Wuhan, China.
The subsequent spread of COVID-19 to the U.S. and many other parts of the world led the World Health Organization to characterize COVID-19 as a pandemic on March 11, 2020. Thereafter, most U.S. states imposed “stay-at-home” orders on their populations to stem the spread of COVID-19. Of specific interest to the Company, stay-at-home orders were imposed in the states of California and Louisiana on March 20, 2020 and March 23, 2020, respectively.
The stay-at-home orders generally required the closure of businesses that did not provide essential functions. Because the Company’s operations at its distribution center in Compton, California and its manufacturing operations in Douglasville, Georgia provide essential functions, the Company has continued shipping, receiving and manufacturing activities at these facilities. The Company advised all other employees that could perform their job functions remotely to do so. As of May 18, 2020, the Company’s Compton, California and Gonzales, Louisiana facilities were fully operational.
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security (the “CARES Act”), which, among other things, outlines the provisions of the Paycheck Protection Program (the “PPP”). The Company determined that it met the criteria to be eligible to obtain a loan under the PPP because, among other reasons, in light of the COVID-19 outbreak and the uncertainty of economic conditions related thereto, the loan was necessary to support the Company’s ongoing operations. Under the PPP, the Company could obtain a U.S. Small Business Administration loan in an amount equal to the average of the Company’s monthly payroll costs (as defined under the PPP) for calendar 2019 multiplied by 2.5 (approximately 10 weeks of payroll costs). Section 1106 of the CARES Act contains provisions for the forgiveness of all or a portion of a PPP loan, subject to the satisfaction of certain requirements. The amount eligible for forgiveness is, subject to certain limitations, the sum of the Company’s payroll costs, rent and utilities paid by the Company during the eight-week period beginning on the funding date of the PPP loan.
On April 19, 2020, the Company closed on a PPP loan in the amount of $1,963,800, which was funded on April 20, 2020 and which was transferred by the Company into an account dedicated to allowable uses of the PPP loan proceeds.
The COVID-19 outbreak and the uncertainty of economic conditions relating thereto may negatively impact the Company’s results of operations, cash flows and financial position; however, the overall financial impact cannot be reasonably estimated at this time. Based on the operational and financial plans that management has developed, the Company expects to be able to meet its obligations as they become due over the next twelve months.
Competition
The infant and toddler consumer products industry is highly competitive. The Company competes with a variety of distributors and manufacturers (both branded and private label), including large infant and juvenile product companies and specialty infant and juvenile product manufacturers, on the basis of quality, design, price, brand name recognition, service and packaging. The Company’s ability to compete depends principally on styling, price, service to the retailer and continued high regard for the Company’s products and trade names.
Employees
As of May 18, 2020, the Company had 138 employees, none of whom is represented by a labor union or is otherwise a party to a collective bargaining agreement. The Company attracts and maintains qualified personnel by paying competitive salaries and benefits and offering opportunities for advancement. The Company considers its relationship with its employees to be good.
Seasonality and Inventory Management
There are no significant variations in the seasonal demand for the Company’s products from year to year. Sales are generally higher in periods when customers take initial shipments of new products, as these orders typically include enough products for initial sets for each store and additional quantities for the customer’s distribution centers. The timing of these initial shipments varies by customer and depends on when the customer finalizes store layouts for the upcoming year and whether the customer has any mid-year introductions of products. Sales may also be higher or lower, as the case may be, in periods when customers are restricting internal inventory levels. Consistent with the expected introduction of specific product offerings, the Company carries necessary levels of inventory to meet the anticipated delivery requirements of its customers. Customer returns of merchandise shipped are historically less than 1% of gross sales.
Trademarks, Copyrights and Patents
The Company considers its intellectual property to be of material importance to its business. Sales of products marketed under the Company’s trademarks, including NoJo®, Neat Solutions®, Carousel Designs® and Sassy®, accounted for 36% and 38% of the Company’s total gross sales during fiscal years 2020 and 2019, respectively. Protection for these trademarks is obtained through domestic and foreign registrations. The Company also markets designs which are subject to copyrights and design patents owned by the Company.
Products
The Company's primary focus is on infant, toddler and juvenile products, including the following:
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infant and toddler bedding
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blankets and swaddle blankets
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nursery and toddler accessories
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room décor
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reusable and disposable bibs
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burp cloths
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hooded bath towels and washcloths
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reusable and disposable placemats and floor mats
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disposable toilet seat covers and changing mats
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developmental toys
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feeding and care goods
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other infant, toddler and juvenile soft goods
Customers
The Company's customers consist principally of mass merchants, mid-tier retailers, juvenile specialty stores, value channel stores, grocery and drug stores, restaurants, internet accounts and wholesale clubs. The Company does not enter into long-term or other purchase agreements with its customers. The table below sets forth those customers that represented at least 10% of the Company’s gross sales in fiscal years 2020 and 2019.
* Amount represented less than 10% of the Company's gross sales for this fiscal year.
Sales and Marketing
The Company’s products are marketed through a national sales force consisting of salaried sales executives and employees located in Compton, California; Gonzales, Louisiana; Grand Rapids, Michigan; and Bentonville, Arkansas and by independent commissioned sales representatives located throughout the United States. Products are also marketed directly to consumers from a Company facility in Douglasville, Georgia. The Company's subsidiaries introduce new products throughout the year and participate at the Kind + Jugend international trade fair for premium baby and toddler products in Cologne, Germany. Due to COVID-19, the Company will not participate at this trade fair in calendar 2020; however, it is expected that the Company will attend in calendar 2021.
Government Regulation and Environmental Control
The Company is subject to various federal, state and local environmental laws and regulations, which regulate, among other things, product safety and the discharge, storage, handling and disposal of a variety of substances and wastes, and to laws and regulations relating to employee safety and health, principally the Occupational Safety and Health Administration Act and regulations thereunder. The Company believes that it currently complies in all material respects with applicable environmental, health and safety laws and regulations and that future compliance with such existing laws or regulations will not have a material adverse effect on its capital expenditures, earnings or competitive position. However, there is no assurance that such requirements will not become more stringent in the future or that the Company will not have to incur significant costs to comply with such requirements.
Product Sourcing
Foreign and domestic contract manufacturers produce most of the Company’s products, with the largest concentration being in China. The Company makes sourcing decisions on the basis of 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. The Company’s management and quality assurance personnel visit the third-party facilities regularly to monitor and audit product quality and to ensure compliance with labor requirements and social and environmental standards. In addition, the Company closely monitors the currency exchange rate. The impact of future fluctuations in the exchange rate or changes in safeguards cannot be predicted with certainty. The Company also produces some of its products domestically at a Company facility located in Douglasville, Georgia.
The Company maintains a foreign representative office located in Shanghai, China, which is responsible for the coordination of production, purchases and shipments, seeking out new vendors and overseeing inspections for social compliance and quality.
The Company’s products are warehoused and distributed from leased facilities located in Compton, California and Douglasville, Georgia.
Product Design and Styling
The Company believes that its creative team is one of its key strengths. The Company’s product designs are primarily created internally and are supplemented by numerous additional sources, including independent artists, decorative fabric manufacturers and apparel designers. Ideas for product design creations are drawn from various sources and are reviewed and modified by the design staff to ensure consistency within the Company’s existing product offerings and the themes and images associated with such existing products. In order to respond effectively to changing consumer preferences, the Company’s designers and stylists attempt to stay abreast of emerging lifestyle trends in color, fashion and design. When designing products under the Company’s various licensed brands, the Company’s designers coordinate their efforts with the licensors’ design teams to provide for a more fluid design approval process and to effectively incorporate the image of the licensed brand into the product. The Company’s designs include traditional, contemporary, textured and whimsical patterns across a broad spectrum of retail price points. Utilizing state of the art computer technology, the Company continually develops new designs throughout the year for all of its product groups. This continual development cycle affords the Company design flexibility, multiple opportunities to present new products to customers and the ability to provide timely responses to customer demands and changing market trends. The Company also creates designs for exclusive sale by certain of its customers under the Company’s brands, as well as the customers’ private label brands.
Licensed Products
Certain products are manufactured and sold pursuant to licensing agreements for trademarks. Also, many of the designs used by the Company are copyrighted by other parties, including trademark licensors, and are available to the Company through copyright license agreements. The licensing agreements are generally for an initial term of one to three years and may or may not be subject to renewal or extension. Sales of licensed products represented 40% of the Company’s gross sales in fiscal year 2020, which included 30% of sales under the Company's license agreements with affiliated companies of The Walt Disney Company (“Disney”), which expire as set forth below:
ITEM 1A.
ITEM 1A. Risk Factors
The following risk factors as well as the other information contained in this report and other filings made by the Company with the SEC should be considered in evaluating the Company’s business. Additional risks and uncertainties that are not presently known or that are not currently considered material may also impair the Company’s business operations. If any of the following risks actually occur, operating results may be affected in future periods.
The outbreak of COVID-19 may adversely affect the Company’s business operations, employee availability, financial condition, liquidity and cash flow.
The COVID-19 outbreak, and the government and private sector responses thereto, has negatively impacted certain of the Company’s customers who have been forced to temporarily close retail stores or have seen a significant decline in their sales. As a result, the Company experienced a decrease in sales to these customers beginning in March 2020. This decrease, however, has been somewhat offset by higher sales to other customers and sales in other channels, such as e-commerce. The Company cannot predict with certainty when or if these customers will reopen their retail stores or if demand from consumers will return to the same level as it was prior to the COVID-19 outbreak. If the Company’s customers experience financial difficulties as a result of the COVID-19 outbreak, they may close their retail stores permanently, reduce orders, file for bankruptcy or liquidate, any of which may negatively impact the Company’s sales.
In addition, beginning in February 2020 the Company experienced supply chain disruption because nearly all of the Company’s products are imported from China. While the Company’s product supply from Chinese manufacturers has begun to return to normal levels, the supply chain could again be disrupted if there is another outbreak of COVID-19 in China. As of May 18, 2020, the majority of the Company’s foreign suppliers have returned to full capacity.
As discussed above, the Company has continued to operate its distribution center in Compton, California and its manufacturing operations in Douglasville, Georgia. While the Company has implemented additional safety measures for its workers in these facilities, the Company may be required to temporarily close these facilities if there are confirmed cases of COVID-19 at the facilities, which would impact the Company’s ability to timely ship products to its customers.
In addition to the specific risks described above, the Company may also be subject to the effects that the COVID-19 outbreak will have on the U.S. economy in general, including high rates of unemployment and a potential economic recession. These effects may reduce consumers’ discretionary spending and, accordingly, the demand for the Company’s products.
The Company continues to monitor the impact of the COVID-19 outbreak 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 when governmental restrictions on business will be fully lifted, the impact thereof, and the duration and widespread nature of the COVID-19 outbreak, the Company cannot currently predict the long-term impact on its operations and financial results. The uncertainties associated with the COVID-19 outbreak 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 outbreak 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.
The loss of one or more of the Company’s key customers could result in a material loss of revenues.
The Company’s top two customers represented approximately 62% of gross sales in fiscal year 2020. Although the Company does not enter into contracts with its key customers, it expects its key customers to continue to be a significant portion of its gross sales in the future. The loss of, or a decline in orders from, one or more of these customers could result in a material decrease in the Company’s revenue and operating income.
The loss of one or more of the Company’s licenses could result in a material loss of revenues.
Sales of licensed products represented 40% of the Company’s gross sales in fiscal year 2020, which included 30% of sales associated with the Company’s license agreements with Disney. The Company could experience a material loss of revenues if it is unable to renew its major license agreements or obtain new licenses. The volume of sales of licensed products is inherently tied to the success of the characters, films and other licensed programs of the Company’s licensors. A decline in the popularity of these licensed programs or the inability of the licensors to develop new properties for licensing could also result in a material loss of revenues to the Company. Additionally, the Company’s license agreements with Disney and others require a material amount of minimum guaranteed royalty payments. The failure by the Company to achieve the sales envisioned by the license agreements could result in the payment by the Company of shortfalls in the minimum guaranteed royalty payments, which would adversely impact the Company’s operating results.
The strength of the Company’s competitors may impact the Company’s ability to maintain and grow its sales, which could decrease the Company’s revenues.
The infant and toddler consumer products industry is highly competitive. The Company competes with a variety of distributors and manufacturers, both branded and private label. The Company’s ability to compete successfully depends principally on styling, price, service to the retailer and continued high regard for the Company’s products and trade names. Several of these competitors are larger than the Company and have greater financial resources than the Company, and some have experienced financial challenges from time to time, including servicing significant levels of debt. Those facing financial pressures could choose to make particularly aggressive pricing decisions in an attempt to increase revenue. The effects of increased competition could result in a material decrease in the Company’s revenues.
The Company’s business is impacted by general economic conditions and related uncertainties, including a declining birthrate, affecting markets in which the Company operates.
The Company’s growth is largely dependent upon growth in the birthrate, and in particular, the rate of first births. Economic conditions, including the real and perceived threat of a recession, could lead individuals to decide to forgo or delay having children. Even under optimal economic conditions, shifts in demographic trends and preferences could have the consequence of individuals starting to have children later in life and/or having fewer children. In recent years, the birthrate in the United States has steadily declined. These conditions could result in reduced demand for some of the Company’s products, increased order cancellations and returns, an increased risk of excess and obsolete inventories and increased pressure on the prices of the Company’s products. Also, although the Company’s use of a commercial factor significantly reduces the risk associated with collecting accounts receivable, the factor may at any time terminate or limit its approval of shipments to a particular customer, and the likelihood of the factor doing so may increase due to a change in economic conditions. Such an action by the factor could result in the loss of future sales to the affected customer.
The Company’s success is dependent upon retaining key management personnel.
Certain of the Company’s executive management and other key personnel have been integral to the Company’s operations and the execution of its growth strategy. The departure from the Company of one or more of these individuals, along with the inability of the Company to attract qualified and suitable individuals to fill the Company’s open positions, could adversely impact the Company’s growth and operating results.
The Company may need to write down or write off inventory.
If product programs end before the inventory is completely sold, then the remaining inventory may have to be sold at less than carrying value. The market value of certain inventory items could drop to below carrying value after a decline in sales, at the end of programs, or when management makes the decision to exit a product group. Such inventory would then need to be written down to the lower of carrying or market value, or possibly completely written off, which would adversely affect the Company’s operating results.
Recalls or product liability claims could increase costs or reduce sales.
The Company must comply with the Consumer Product Safety Improvement Act, which imposes strict standards to protect children from potentially harmful products and which requires that the Company’s products be tested to ensure that they are within acceptable levels for lead and phthalates. The Company must also comply with related regulations developed by the Consumer Product Safety Commission and similar state regulatory authorities. The Company’s products could be subject to involuntary recalls and other actions by these authorities, and concerns about product safety may lead the Company to voluntarily recall, accept returns or discontinue the sale of select products. Product liability claims could exceed or fall outside the scope of the Company’s insurance coverage. Recalls or product liability claims could result in decreased consumer demand for the Company’s products, damage to the Company’s reputation, a diversion of management’s attention from its business and increased customer service and support costs, any or all of which could adversely affect the Company’s operating results.
Disruptions to the Company’s information technology systems could negatively affect the Company’s results of operations.
The Company’s operations are highly dependent upon computer hardware and software systems, including customized information technology systems and cloud-based applications. The Company also employs third-party systems and software that are integral to its operations. These systems are vulnerable to cybersecurity incidents, including disruptions and security breaches, which can result from unintentional events or deliberate attacks by insiders or third parties, such as cybercriminals, competitors, nation-states, computer hackers and other cyber terrorists. The Company faces an evolving landscape of cybersecurity threats in which evildoers use a complex array of means to perpetrate attacks, including the use of stolen access credentials, malware, ransomware, phishing, structured query language injection attacks and distributed denial-of-service attacks. The Company has implemented security measures to securely maintain confidential and proprietary information stored on the Company’s information systems and continually invests in maintaining and upgrading the systems and applications to mitigate these risks. There can be no assurance that these measures and technology will adequately prevent an intrusion or that a third party that is relied upon by the Company will not suffer an intrusion, that unauthorized individuals will not gain access to confidential or proprietary information or that any such incident will be timely detected and effectively countered. A significant data security breach could result in negative consequences, including a disruption to the Company’s operations and substantial remediation costs, such as liability for stolen assets or information, repairs of system damage, and incentives to customers or other business partners in an effort to maintain relationships after an attack. An assault against the Company’s information technology infrastructure could also lead to other adverse impacts to its results of operations such as increased future cybersecurity protection costs, which may include the costs of making organizational changes, deploying additional personnel and protection technologies, and engaging third-party experts and consultants.
Economic conditions could result in an increase in the amounts paid for the Company’s products.
Significant increases in the price of raw materials that are components of the Company’s products, including cotton, oil and labor, could adversely affect the amounts that the Company must pay its suppliers for its finished goods. If the Company is unable to pass these cost increases along to its customers, its profitability could be adversely affected.
The Company’s ability to successfully identify, consummate and integrate acquisitions, divestitures and other significant transactions could have an adverse impact on the Company’s financial results, business and prospects.
As part of its business strategy, the Company has made acquisitions of businesses, divestitures of businesses and assets, and has entered into other transactions to further the interests of the Company’s business and its stockholders. Risks associated with such activities include the following, any of which could adversely affect the Company’s financial results:
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The active management of acquisitions, divestitures and other significant transactions requires varying levels of Company resources, including the efforts of the Company’s key management personnel, which could divert attention from the Company’s ongoing business operations.
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The Company may not fully realize the anticipated benefits and expected synergies of any particular acquisition or investment, or may experience a prolonged timeframe for realizing such benefits and synergies.
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Increased or unexpected costs, unanticipated delays or failure to meet contractual obligations could make acquisitions and investments less profitable or unprofitable.
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The failure to retain executive management members and other key personnel of the acquired business that may have been integral to the operations and the execution of the growth strategy of the acquired business.
The Company could experience losses associated with its intellectual property.
The Company relies upon the fair interpretation and enforcement of patent, copyright, trademark and trade secret laws in the U.S., similar laws in other countries, and agreements with employees, customers, suppliers, licensors and other parties. Such reliance serves to establish and maintain the intellectual property rights associated with the products that the Company develops and sells. However, the laws and courts of certain countries at times do not protect intellectual property rights or respect contractual agreements to the same extent as the laws of the U.S. Therefore, in certain jurisdictions the Company may not be able to protect its intellectual property rights against counterfeiting or enforce its contractual agreements with other parties. In addition, another party could claim that the Company is infringing upon such party’s intellectual property rights, and claims of this type could lead to a civil complaint.
An unfavorable outcome in litigation involving intellectual property could result in any or all of the following: (i) civil judgments against the Company, which could require the payment of royalties on both past and future sales of certain products, as well as plaintiff’s attorneys’ fees and other litigation costs; (ii) impairment charges of up to the carrying value of the Company’s intellectual property rights; (iii) restrictions on the ability of the Company to sell certain of its products; (iv) legal and other costs associated with investigations and litigation; and (v) adverse effects on the Company’s competitive position.
A significant disruption to the Company’s distribution network or to the timely receipt of inventory could adversely impact sales or increase transportation costs, which would decrease the Company’s profits.
Nearly all of the Company’s products are imported from China into the Port of Long Beach in Southern California. There are many links in the distribution chain, including the availability of ocean freight, cranes, dockworkers, containers, tractors, chassis and drivers. The timely receipt of the Company’s products is also dependent upon efficient operations at the Port of Long Beach. Any shortages in the availability of any of these links or disruptions in port operations, including strikes, lockouts or other work stoppages or slowdowns, could cause bottlenecks and other congestion in the distribution network, which could adversely impact the Company’s ability to obtain adequate inventory on a timely basis and result in lost sales, increased transportation costs and an overall decrease of the Company’s profits.
The Company’s sourcing and marketing operations in foreign countries are subject to anti-corruption laws.
The Company’s foreign operations are subject to laws prohibiting improper payments and bribery, including the U.S. Foreign Corrupt Practices Act and similar laws and regulations in foreign jurisdictions, which apply to the Company’s directors, officers, employees and agents acting on behalf of the Company. Failure to comply with these laws could result in damage to the Company’s reputation, a diversion of management’s attention from its business, increased legal and investigative costs, and civil and criminal penalties, any or all of which could adversely affect the Company’s operating results.
Customer pricing pressures could result in lower selling prices, which could negatively affect the Company’s operating results.
The Company’s customers could place pressure on the Company to reduce the prices of its products. The Company continuously strives to stay ahead of its competition in sourcing, which allows the Company to obtain lower cost products while maintaining high standards for quality. There can be no assurance that the Company could respond to a decrease in sales prices by proportionately reducing its costs, which could adversely affect the Company’s operating results.
The Company’s inability to anticipate and respond to consumers’ tastes and preferences could adversely affect the Company’s revenues.
Sales are driven by consumer demand for the Company’s products. There can be no assurance that the demand for the Company’s products will not decline or that the Company will be able to anticipate and respond to changes in demand related to consumers’ tastes and preferences. The Company’s failure to adapt to these changes could lead to lower sales and excess inventory, which could have a material adverse effect on the Company’s financial condition and operating results.
Changes in international trade regulations and other risks associated with foreign trade could adversely affect the Company’s sourcing.
The Company sources its products primarily from foreign contract manufacturers, with the largest concentration being in China. Difficulties encountered by these suppliers, such as fires, accidents, natural disasters, outbreaks of infectious diseases (including the COVID-19 outbreak) and the instability inherent in operating within an authoritarian political structure, could halt or disrupt production and shipment of the Company’s products. The Chinese government could make allegations against the Company of corruption or antitrust violations, or could adopt regulations related to the manufacture of products within China, including quotas, duties, taxes and other charges or restrictions on the exportation of goods produced in China. Alternatively, the U.S. government could impose similar actions on the importation of goods manufactured in China. Any of these actions could result in an increase in the cost of the Company’s products. Also, an arbitrary strengthening of the Chinese currency versus the U.S. Dollar could increase the prices at which the Company purchases finished goods. In addition, changes in U.S. customs procedures or delays in the clearance of goods through customs could result in the Company being unable to deliver goods to customers in a timely manner or the potential loss of sales altogether. The occurrence of any of these events could adversely affect the Company’s profitability.
The Company could experience adjustments to its effective tax rate or its prior tax obligations, either of which could adversely affect its results of operations.
The Company is subject to income taxes in the many jurisdictions in which it operates, including the U.S., several U.S. states and China. At any particular point in time, several tax years are subject to general examination or other adjustment by these various jurisdictions. In December 2016, the Company received notification from the Franchise Tax Board of the State of California (the “FTB”) of its intention to examine the Company’s claims for refund made in connection with amended consolidated income tax returns that the Company had filed for the fiscal years ended April 3, 2011, April 1, 2012, March 31, 2013 and March 30, 2014. On July 31, 2019, the FTB notified the Company that it would take no further action with regard to the claims for refund for fiscal years ended April 3, 2011, April 1, 2012 and March 31, 2013. The ultimate resolution of the claim for refund for the fiscal year ended March 30, 2014 could include administrative or legal proceedings. Although the Company believes that the calculations and positions taken on its original and amended filed returns are reasonable and justifiable, negotiations or litigation leading to the final outcome of any examination or claim for refund could result in an adjustment to the position that the Company has taken. Such adjustment could result in further adjustment to one or more income tax returns for other jurisdictions, or to income tax returns for prior or subsequent tax years, or both. To the extent that the Company’s reserve for unrecognized tax benefits is not adequate to support the cumulative effect of such adjustments, the Company could experience a material adverse impact on operating results. The Company’s provision for income taxes is based on its effective tax rate, which in any given financial statement period could fluctuate based on changes in tax laws or regulations, changes in the mix and level of earnings by taxing jurisdiction, changes in the amount of certain expenses within the consolidated statements of income that will never be deductible on the Company’s income tax returns and certain charges deducted on the Company’s income tax returns that are not included within the consolidated statements of income. These changes could cause fluctuations in the Company’s effective tax rate either on an absolute basis, or in relation to varying levels of the Company’s pre-tax income. Such fluctuations in the Company’s effective tax rate could adversely affect its results of operations.
The Company’s ability to comply with its credit facility is subject to future performance and other factors.
The Company’s ability to make required payments of principal and interest on its debts, to refinance its maturing indebtedness, to fund capital expenditures or to comply with its debt covenants will depend upon future performance. The Company’s future performance is, to a certain extent, subject to general economic, financial, competitive, legislative, regulatory and other factors beyond its control. The breach of any of the debt covenants could result in a default under the Company’s credit facility. Upon the occurrence of an event of default, the Company’s lender could make an immediate demand of the amount outstanding under the credit facility. If a default was to occur and such a demand was to be made, there can be no assurance that the Company’s assets would be sufficient to repay the indebtedness in full.
The Company’s debt covenants may affect its liquidity or limit its ability to pursue acquisitions, incur debt, make investments, sell assets or complete other significant transactions.
The Company’s credit facility contains usual and customary covenants regarding significant transactions, including restrictions on other indebtedness, liens, transfers of assets, investments and acquisitions, merger or consolidation transactions, transactions with affiliates and changes in or amendments to the organizational documents for the Company and its subsidiaries. Unless waived by the Company’s lender, these covenants could limit the Company’s ability to pursue opportunities to expand its business operations, respond to changes in business and economic conditions and obtain additional financing, or otherwise engage in transactions that the Company considers beneficial.
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or failure by the Company to adequately comply with new laws and regulations could substantially harm its results of operations.
The Company is subject to laws and regulations governing the Internet and e-commerce. On June 21, 2018, the U.S. Supreme Court issued its decision in South Dakota v. Wayfair, Inc., et al. The Court held that a state may require a business to collect and remit sales taxes even if the business has no physical presence within the state. In response, most states have enacted laws or otherwise issued administrative guidance regarding their intent to require the collection and remittance of sales tax on orders of products that are made through the Internet and are subsequently shipped to customers within their states. The Company routinely makes shipments of its products into thousands of jurisdictions throughout the U.S. within which the Company does not have a physical presence. The Wayfair decision is central to an evolving framework of laws and regulations that is subject to interpretation and application in a manner that is inconsistent from one jurisdiction to another. The Company cannot assure that its practices have complied, are currently complying, or will comply fully and adequately with all such laws and regulations. Any failure to comply with any of these laws or regulations could result in damage to the Company’s reputation or a loss or reduction of orders. As the Company complies with such laws and regulations by charging, collecting and remitting sales tax, its customers will see an immediate and significant increase in the total order cost of the Company’s products as such taxes are imposed, which will make the pricing of the Company’s products less competitive when compared with a business that might not be required to charge, collect and remit sales taxes. Also, the Company’s application for registration for sales tax within a jurisdiction will often trigger obligations for other licensing and filing requirements within the jurisdiction. Compliance with such laws and regulations will place an additional burden on the Company by requiring a significant investment and continuing costs, as well as efforts of the Company’s key management personnel. Also, the Company at any time could be subjected to examinations by any of the jurisdictions into which the Company may have at one time or another shipped its products, which could result in the assessment on the Company of a significant accumulation of uncollected taxes, along with penalties and interest. The occurrence of any of these events could adversely affect the Company’s financial position and operating results.
A stockholder could lose all or a portion of his or her investment in the Company.
The Company’s common stock has historically experienced a degree of price variability, and the price could be subject to rapid and substantial fluctuations. The Company’s common stock has also historically been thinly traded, a circumstance that exists when there is a relatively small volume of buy and sell orders for the Company’s common stock at any given point in time. In such situations, a stockholder may be unable to liquidate his or her position in the Company’s common stock at the desired price. Also, as an equity investment, a stockholder’s investment in the Company is subordinate to the interests of the Company’s creditors, and a stockholder could lose all or a substantial portion of his or her investment in the Company in the event of a voluntary or involuntary bankruptcy filing or liquidation.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
The Company's headquarters are located in Gonzales, Louisiana. The Company rents 17,761 square feet at this location under a lease that expires January 31, 2021. Management believes that its properties are suitable for the purposes for which they are used, are in generally good condition and provide adequate capacity for current and anticipated future operations. The table below sets forth certain information regarding the Company's principal real property as of May 18, 2020.
ITEM 3.
ITEM 3. Legal Proceedings
The Company is, from time to time, involved in various legal proceedings relating to claims arising in the ordinary course of its business. Neither the Company nor any of its subsidiaries is a party to any such legal proceeding the outcome of which, individually or in the aggregate, is expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows.
ITEM 4.
ITEM 4. Mine Safety Disclosures
Not applicable.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company's common stock is traded on the Nasdaq Capital Market under the symbol “CRWS”. As of May 18, 2020, there were 152 record holders of the Company’s common stock.
The Company has historically paid cash dividends. The Company’s payment of dividends is and will continue to be restricted by or subject to, among other limitations, applicable provisions of federal and state laws, the Company’s earnings and various business considerations, including the Company’s financial condition, results of operations, cash flow, level of capital expenditures, future business prospects and such other matters as the Company’s Board of Directors (the “Board”) deems relevant. The Company’s credit facility permits the Company to pay cash dividends on its common stock without limitation, provided there is no default under the credit facility before or as a result of the payment of such dividends.
For information regarding securities of the Company that have been authorized for issuance under equity compensation plans, refer to “Securities Authorized for Issuance under Equity Compensation Plans” in Item 12. of Part III of this Annual Report on Form 10-K.
ITEM 6.
ITEM 6. Selected Financial Data
The information set forth below is not necessarily indicative of the Company’s future financial position or operating results and should be read in conjunction with Item 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is intended to provide information concerning certain factors that management considers important in reviewing the Company’s results of operations, financial position, liquidity and capital resources. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
Results of Operations
The following table contains results of operations for fiscal years 2020 and 2019 and the dollar and percentage changes for those periods (in thousands, except percentages).
Net Sales:
Sales of $73.4 million for 2020 were $3.0 million lower than 2019, a decrease of 3.9%, primarily due to the timing of shipments to certain retailers as well as a program that was discontinued during the second quarter of 2020. Sales of bibs, bath, developmental toys, feeding, baby care and disposable products in the current year decreased by $360,000 over the prior year, while sales of bedding, blankets and accessories in the current year decreased by $2.6 million.
Gross Profit:
Gross profit decreased by $717,000 and increased from 29.2% of net sales for 2019 to 29.4% of net sales for 2020. The decrease in amount is primarily due to lower sales in the current year.
Marketing and Administrative Expenses:
Marketing and administrative expenses decreased by $1.3 million for fiscal year 2020 compared with fiscal year 2019, which included a decrease in the current year of $525,000 in overall compensation costs as compared to the prior year. In addition, charges in the current year for outside services and advertising decreased by $284,000 and $122,000, respectively, as compared to the prior year. Finally, the prior year included $210,000 in charges incurred that were associated with transferring most of the Sassy-branded developmental toy, feeding and baby care product line inventory from Grand Rapids, Michigan to the Company’s distribution facility in Compton, California.
Income Tax Expense:
The Company’s provision for income taxes is based upon an annual effective tax rate (“ETR”) on continuing operations, which decreased from 24.4% during 2019 to 24.0% in 2020.
Management evaluates items of income, deductions and credits reported on the Company’s various federal and state income tax returns filed and recognizes the effect of positions taken on those income tax returns only if those positions are more likely than not to be sustained. The Company applies the provisions of accounting guidelines that require a minimum recognition threshold that a tax benefit must meet before being recognized in the financial statements. Recognized income tax positions are measured at the largest amount that has a greater than 50% likelihood of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
After considering all relevant information regarding the calculation of the state portion of its income tax provision, the Company believes that the technical merits of the tax position that the Company has taken with respect to state apportionment percentages would more likely than not be sustained. However, the Company also realizes that the ultimate resolution of such tax position could result in a tax charge that is more than the amount realized based upon the application of the tax position taken. Therefore, the Company’s measurement regarding the tax impact of the revised state apportionment percentages resulted in the Company recording discrete reserves for unrecognized tax liabilities during fiscal years 2020 and 2019 of $58,000 and $87,000, respectively, in the accompanying consolidated statements of income.
In December 2016, the Company was notified by the FTB of its intention to examine the Company’s claims for refund made in connection with amended consolidated income tax returns that the Company had filed for the fiscal years ended March 30, 2014, March 31, 2013, April 1, 2012 and April 3, 2011. On July 31, 2019, the FTB notified the Company that it would take no further action with regard to the fiscal years ended March 31, 2013, April 1, 2012 and April 3, 2011. In addition, on January 7, 2020, the Company’s California consolidated income tax return for the fiscal year ended March 29, 2015 became closed to examination or other adjustment. Accordingly, the Company reversed the reserves for unrecognized tax liabilities that it had previously recorded for these fiscal years, which resulted in the recognition of a discrete income tax benefit of $444,000 during the fiscal year ended March 29, 2020 in the accompanying consolidated statements of income.
During the fiscal year ended March 29, 2020, the Company recorded a discrete income tax benefit of $274,000 to reflect the aggregate effect of certain tax credits claimed on amended and original consolidated federal income tax returns.
During the fiscal years ended March 29, 2020 and March 31, 2019, the Company recorded discrete income tax charges of $5,000 and $12,000, respectively, to reflect the 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 discussed above contributed to an overall provision for income taxes of 15.5% and 26.1% for fiscal years 2020 and 2019, respectively.
Known Trends and Uncertainties
The Company’s financial results are closely tied to sales to the Company’s top two customers, which represented approximately 62% of the Company’s gross sales in fiscal year 2020. A significant downturn experienced by any or all of these customers could lead to pressure on the Company’s revenues.
During fiscal years 2020 and 2019, the Company at times faced higher costs associated with the Company’s sourcing activities in China, including higher duties on some products. Future increases in these costs could adversely affect the profitability of the Company if it cannot pass the cost increases along to its customers in the form of price increases or if the timing of price increases does not closely match the cost increases.
The COVID-19 outbreak, and the government and private sector responses thereto, has negatively impacted certain of the Company’s customers who have been forced to temporarily close retail stores or have seen a significant decline in their sales. As a result, the Company experienced a decrease in sales to these customers beginning in March 2020. This decrease, however, has been somewhat offset by higher sales to other customers and sales in other channels, such as e-commerce. The Company cannot predict with certainty when or if these customers will reopen their retail stores or if demand from consumers will return to the same level as it was prior to the COVID-19 outbreak. If the Company’s customers experience financial difficulties as a result of the COVID-19 outbreak, they may cause them to close their retail stores permanently, reduce orders, file for bankruptcy or liquidate, any of which may negatively impact the Company’s sales.
In addition, beginning in February 2020 the Company experienced supply chain disruption because nearly all of the Company’s products are imported from China. While the Company’s product supply from Chinese manufacturers has begun to return to normal levels, the supply chain could again be disrupted if there is another outbreak of COVID-19 in China. As of May 18, 2020, the majority of the Company’s foreign suppliers have returned to full capacity.
The Company continues to monitor the impact of the COVID-19 outbreak 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 when governmental restrictions on business will be fully lifted, the impact thereof, and the duration and widespread nature of the COVID-19 outbreak, the Company cannot currently predict the long-term impact on its operations and financial results. The uncertainties associated with the COVID-19 outbreak 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 outbreak 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.
For an additional discussion of trends, uncertainties and other factors that could impact the Company’s operating results, refer to “Risk Factors” in Item 1A. of Part I. of this Annual Report on Form 10-K.
Financial Position, Liquidity and Capital Resources
Net cash provided by operating activities decreased from $9.0 million for the fiscal year ended March 31, 2019 to $8.5 million for the fiscal year ended March 29, 2020. In the current year, the Company experienced a decrease in its accounts payable balances that was $1.7 million higher than the increase in the prior year, an increase in its accounts receivable balances that was $757,000 higher than the decrease in the prior year and a decrease in its reserve for unrecognized tax liabilities that was $650,000 higher than the increase in the prior year. As offsets to these decreases in cash provided by operating activities, the Company in the current year experienced a decrease in its inventory balances that was $1.5 million higher than the decrease in the prior year and an increase its net income in the current year that was $1.5 million higher than in the prior year.
Net cash used in investing activities was $678,000 in fiscal year 2020 compared with $751,000 in fiscal year 2019. The decrease in fiscal year 2020 was due primarily to lower payments in the current year for expenditures for property, plant and equipment.
Net cash used in financing activities decreased from $8.3 million in fiscal 2019 to $7.7 million in fiscal 2019. In the current year, the Company experienced net repayments under its revolving line of credit that were $3.1 million lower than the prior year. Offsetting this decrease in cash used in financing activities were dividend payments that were $2.6 million higher in the current year than the prior year, due primarily to the payment in the current year of a special dividend in the amount of $2.5 million.
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 the availability on its revolving line of credit will be adequate to meet its liquidity needs.
The Company’s credit facility at March 29, 2020 consisted of a revolving line of credit under a financing agreement with The CIT Group/Commercial Services, Inc. (“CIT”), a subsidiary of CIT Group Inc., of up to $26.0 million, which includes a $1.5 million sub-limit for letters of credit, bearing interest at the rate of prime minus 0.5% or LIBOR plus 1.75%. The financing agreement matures on July 11, 2022 and is secured by a first lien on all assets of the Company. As of March 29, 2020, the Company had elected to pay interest on balances owed under the revolving line of credit under the LIBOR option, which was 3.27% as of March 29, 2020. The financing agreement also provides for the payment by CIT to the Company of interest at the rate of prime as of the beginning of the calendar month minus 2.0%, which was 2.75% as of March 29, 2020, on daily negative balances, if any, held at CIT.
As of March 29, 2020, there was a balance of $2.6 million owed on the revolving line of credit, there was no letter of credit outstanding and $20.1 million was available under the revolving line of credit based on the Company’s eligible accounts receivable and inventory balances. As of March 31, 2019, there was a balance of $4.5 million owed on the revolving line of credit, there was no letter of credit outstanding and $19.4 million was available under the revolving line of credit based on the Company’s eligible accounts receivable and inventory balances.
The financing agreement contains usual and customary covenants for agreements of that type, including limitations on other indebtedness, liens, transfers of assets, investments and acquisitions, merger or consolidation transactions, transactions with affiliates, and changes in or amendments to the organizational documents for the Company and its subsidiaries. The Company believes it was in compliance with these covenants as of March 29, 2020.
To reduce its exposure to credit losses, the Company assigns the majority of its trade accounts receivable to CIT pursuant to factoring agreements, which have expiration dates that are coterminous with that of the financing agreement described above. Under the terms of the factoring agreements, CIT remits customer payments to the Company as such payments are received by CIT.
CIT bears credit losses with respect to assigned accounts receivable from approved shipments, 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 occurs, the Company either assumes (and may seek to mitigate) the credit risk for shipments to the customer after the date of such termination or limitation or discontinues shipments to the customer. Factoring fees, which are included in marketing and administrative expenses in the accompanying consolidated statements of income, were $255,000 and $261,000 during fiscal years 2020 and 2019, respectively. There were no advances on the factoring agreements at March 29, 2020 or March 31, 2019.
The Company continues to monitor the impact of the COVID-19 outbreak 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 when governmental restrictions on business will be fully lifted, the impact thereof, and the duration and widespread nature of the COVID-19 outbreak, the Company cannot currently predict the long-term impact on its operations and financial results. The uncertainties associated with the COVID-19 outbreak 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 outbreak 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, the proceeds from the PPP loan and the availability under its revolving line of credit are sufficient to fund the Company’s requirements for working capital, capital expenditures and debt service for at least the next 12 months.
Critical Accounting Policies and Estimates
The Company prepares its financial statements to conform with accounting principles generally accepted in the U.S. (“GAAP”) as promulgated by the Financial Accounting Standards Board (“FASB”). References herein to GAAP are to topics within the FASB Accounting Standards Codification (the “FASB ASC”), which the FASB periodically revises through the issuance of an Accounting Standards Update (“ASU”) and which has been established by the FASB as the authoritative source for GAAP recognized by the FASB to be applied by nongovernmental entities.
Use of Estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated balance sheets and the reported amounts of revenues and expenses during the reporting period. The listing below, while not inclusive of all of the Company's accounting policies, sets forth those accounting policies which the Company's management believes embody the most significant judgments due to the uncertainties affecting their application and the likelihood that materially different amounts would be reported under different conditions or using different assumptions.
Revenue Recognition: Revenue is recognized upon the satisfaction of all contractual performance obligations and the transfer of control of the products sold to the customer. The majority of the Company’s sales consists of single performance obligation arrangements for which the transaction price for a given product sold is equivalent to the price quoted for the product, net of any stated discounts applicable at a point in time. Each sales transaction results in an implicit contract with the customer to deliver a product as directed by the customer. Shipping and handling costs that are charged to customers are included in net sales, and the Company’s costs associated with shipping and handling activities are included in cost of products sold.
A provision for anticipated returns, which are based upon historical returns and claims, is provided through a reduction of net sales and cost of products sold in the reporting period within which the related sales are recorded. Actual returns and claims experienced in a future period may differ from historical experience, and thus, the Company’s provision for anticipated returns at any given point in time may be over-funded or under-funded. The Company recognizes revenue associated with unredeemed store credits and gift certificates at the earlier of their redemption by customers, their expiration or when their likelihood of redemption becomes remote, which is generally two years from the date of issuance.
Revenue from sales made directly to consumers is recorded when the shipped products have been received by customers, and excludes sales taxes collected on behalf of governmental entities. Revenue from sales made to retailers is recorded when legal title has been passed to the customer based upon the terms of the customer’s purchase order, the Company’s sales invoice, or other associated relevant documents. Such terms usually stipulate that legal title will pass when the shipped products are no longer under the control of the Company, such as when the products are picked up at the Company’s facility by the customer or by a common carrier. Payment terms can vary from prepayment for sales made directly to consumers to payment due in arrears (generally, 60 days of being invoiced) for sales made to retailers.
Allowances Against Accounts Receivable: Revenue from sales made to retailers is reported net of allowances for anticipated returns and other allowances, including cooperative advertising allowances, warehouse allowances, placement fees, volume rebates, coupons and discounts. Such allowances are recorded commensurate with sales activity or using the straight-line method, as appropriate, and the cost of such allowances is netted against sales in reporting the results of operations. The provision for the majority of the Company’s allowances occurs on a per-invoice basis. When a customer requests to have an agreed-upon deduction applied against the customer’s outstanding balance due to the Company, the allowances are correspondingly reduced to reflect such payments or credits issued against the customer’s account balance. The Company analyzes the components of the allowances for customer deductions monthly and adjusts the allowances to the appropriate levels. The timing of funding requests for advertising support can cause the net balance in the allowance account to fluctuate from period to period. The timing of such funding requests should have no impact on the consolidated statements of income since such costs are accrued commensurate with sales activity or using the straight-line method, as appropriate.
Valuation of Long-Lived Assets and Identifiable Intangible Assets: In addition to the systematic annual depreciation and amortization of the Company’s fixed assets and identifiable intangible assets, the Company reviews for impairment long-lived assets and identifiable intangible assets whenever events or changes in circumstances indicate that the carrying amount of any asset may not be recoverable. In the event of impairment, the asset is written down to its fair market value. Assets to be disposed of, if any, are recorded at the lower of net book value or fair market value, less estimated costs to sell at the date management commits to a plan of disposal, and are classified as assets held for sale on the consolidated balance sheets.
Inventory Valuation: On a periodic basis, management reviews its inventory quantities on hand for obsolescence, physical deterioration, changes in price levels and the existence of quantities on hand which may not reasonably be expected to be sold within the Company’s normal operating cycle. To the extent that any of these conditions is believed to exist or the market value of the inventory expected to be realized in the ordinary course of business is otherwise no longer as great as its carrying value, an allowance against the inventory value is established. To the extent that this allowance is established or increased during an accounting period, an expense is recorded in cost of products sold in the Company's consolidated statements of income. Only when inventory for which an allowance has been established is later sold or is otherwise disposed is the allowance reduced accordingly. Significant management judgment is required in determining the amount and adequacy of this allowance. In the event that actual results differ from management's estimates or these estimates and judgments are revised in future periods, the Company may not fully realize the carrying value of its inventory or may need to establish additional allowances, either of which could materially impact the Company's financial position and results of operations.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
Refer to pages 23 and through hereof.
ITEM 9.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
ITEM 9A.
ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures
Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.
Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining for the Company adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act (“ICFR”). With the participation of the Chief Executive Officer and the Chief Financial Officer, management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework and the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on management’s evaluation of ICFR, management has concluded that internal control over financial reporting was effective as of March 29, 2020.
The Company’s internal control system has been designed to provide reasonable assurance to the Company’s management and the Board regarding the reliability of financial reporting and the preparation and fair presentation of financial statements in accordance with GAAP. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only a reasonable, rather than absolute, assurance that the Company’s financial statements are free of any material misstatement, whether caused by error or fraud.
Changes in Internal Control over Financial Reporting
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the Company’s ICFR as required by Rule 13a-15(d) under the Exchange Act and, in connection with such evaluation, determined that no changes occurred during the Company’s fiscal quarter ended March 29, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s ICFR.
ITEM 9B.
ITEM 9B. Other Information
Not applicable.
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
The information with respect to the Company's directors and executive officers will be set forth in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held in 2020 (the "Proxy Statement") under the captions "Proposal 1 - Election of Directors" and “Executive Compensation - Executive Officers” and is incorporated herein by reference. The information with respect to Item 405 of Regulation S-K will be set forth in the Proxy Statement under the caption "Delinquent Section 16(a) Reports " and is incorporated herein by reference. The information with respect to Item 406 of Regulation S-K will be set forth in the Proxy Statement under the caption “Corporate Governance - Code of Business Conduct and Ethics; Code of Conduct for Directors” and is incorporated herein by reference. The information with respect to Item 407 of Regulation S-K will be set forth in the Proxy Statement under the captions “Corporate Governance - Board Committees” and “Report of the Audit Committee” and is incorporated herein by reference.
ITEM 11.
ITEM 11. Executive Compensation
The information set forth under the caption "Executive Compensation" in the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement is incorporated herein by reference.
Securities Authorized for Issuance under Equity Compensation Plans
The table below sets forth information regarding shares of the Company’s common stock that may be issued upon the exercise of options, warrants and other rights granted to employees, consultants or directors under all of the Company’s existing equity compensation plans as of March 29, 2020.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
The information set forth under the captions “Corporate Governance - Director Independence” and "Certain Relationships and Related Transactions" in the Proxy Statement is incorporated herein by reference.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
The information set forth under the caption “Proposal 2 - Ratification of Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
(a)(1). Financial Statements
The following consolidated financial statements of the Company are filed with this report and included in Part II, Item 8.:
(a)(2). Financial Statement Schedule
The following financial statement schedule of the Company is filed with this report:
Schedule II - Valuation and Qualifying Accounts
All other schedules not listed above have been omitted because they are not applicable or the required information is included in the financial statements or notes thereto.
SCHEDULE II
CROWN CRAFTS, INC. AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
(a)(3). Exhibits
Exhibits required to be filed by Item 601 of SEC Regulation S-K are included as Exhibits to this report and listed below.
In reviewing the agreements included as exhibits to this report, investors are reminded that the agreements are included to provide information regarding their terms and are not intended to provide any other factual or disclosure information about the Company or the other parties to the agreements. Some of the agreements contain representations and warranties made by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:
●
Should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;
●
Have been qualified by the disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;
●
May apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and
●
Were made only as of the date of the applicable agreement or such other date or dates may be specified in the agreement and are subject to more recent developments.
Accordingly, the representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about the Company may be found elsewhere in this report and the Company’s other public filings with the SEC.
_______________
* Management contract or a compensatory plan or arrangement.
(1)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated July 23, 2001.
(2)
Incorporated herein by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 28, 2003.
(3)
Incorporated herein by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended March 28, 2004.
(4)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated July 17, 2006.
(5)
Incorporated herein by reference to Registrant’s Registration Statement on Form S-8 dated August 24, 2006.
(6)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated November 9, 2007.
(7)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K/A dated November 7, 2008.
(8)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated November 7, 2008.
(9)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated July 6, 2009.
(10)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated March 8, 2010.
(11)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated May 27, 2010.
(12)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated August 9, 2011.
(13)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated March 27, 2012.
(14)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated March 30, 2012.
(15)
Incorporated herein by reference to Registrant’s Registration Statement on Form S-8 dated August 14, 2012.
(16)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated May 21, 2013.
(17)
Incorporated herein by reference to Appendix A to the Registrant’s Definitive Proxy Statement on Schedule 14A filed on June 27, 2014.
(18)
Incorporated herein by reference to Registrant’s Registration Statement on Form S-8 dated November 10, 2014.
(19)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated December 28, 2015.
(20)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated April 4, 2016.
(21)
Incorporated herein by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended October 2, 2016.
(22)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated November 16, 2016.
(23)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated August 7, 2017.
(24)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated December 18, 2017.
(25)
Incorporated herein by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended July 1, 2018.
(26)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated January 22, 2019.
(27)
Incorporated herein by reference to Registrant’s Current Report on Form 8-K dated April 23, 2020.
(28)
Filed herewith.
(29)
Furnished herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CROWN CRAFTS, INC.
By: /s/ E. Randall Chestnut
E. Randall Chestnut
Chairman of the Board, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signatures
Title
Date
/s/ E. Randall Chestnut
Chairman of the Board,
President and Chief
Executive Officer
(Principal Executive
June 10, 2020
E. Randall Chestnut
Officer)
/s/ Olivia W. Elliott
Vice President and Chief
Financial Officer (Principal
Financial Officer and
Principal Accounting
June 10, 2020
Olivia W. Elliott
Officer)
/s/ Sidney Kirschner
Director
June 10, 2020
Sidney Kirschner
/s/ Zenon S. Nie
Director
June 10, 2020
Zenon S. Nie
/s/ Donald Ratajczak
Director
June 10, 2020
Donald Ratajczak
/s/ Patricia Stensrud
Director
June 10, 2020
Patricia Stensrud
ITEM 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Audited Financial Statements:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of March 29, 2020 and March 31, 2019
Consolidated Statements of Income for the Fiscal Years Ended March 29, 2020 and March 31, 2019
Consolidated Statements of Changes in Shareholders' Equity for the Fiscal Years Ended March 29, 2020 and March 31, 2019
Consolidated Statements of Cash Flows for the Fiscal Years Ended March 29, 2020 and March 31, 2019
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Crown Crafts, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Crown Crafts, Inc. and subsidiaries (the Company) as of March 29, 2020 and March 31, 2019, the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended March 29, 2020, and the related notes and financial statement schedule II (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of March 29, 2020 and March 31, 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended March 29, 2020, in conformity with U.S. generally accepted accounting principles.
Change in Accounting Principle
As discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for leases as of April 1, 2019, due to the adoption of Accounting Standards Codification Topic 842, Leases.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2009.
Baton Rouge, Louisiana
June 10, 2020
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
Crown Crafts, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 - Description of Business
Crown Crafts, Inc. (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 its wholly-owned subsidiaries, NoJo Baby & Kids, Inc. (formerly known as Crown Crafts Infant Products, Inc.) (“NoJo”), Sassy Baby, Inc. (formerly known as Hamco, Inc.) (“Sassy Baby”) and Carousel Designs, LLC (“Carousel”) 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, soft bath products, disposable products, developmental toys and accessories. Sales of the Company’s products are generally made directly to retailers, which are primarily mass merchants, mid-tier retailers, juvenile specialty stores, value channel stores, grocery and drug stores, restaurants, wholesale clubs and internet-based retailers, as well as directly to consumers through www.babybedding.com. The Company’s products are marketed under a variety of Company-owned trademarks, under trademarks licensed from others and as private label goods.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation: The accompanying consolidated financial statements include the accounts of the Company and have been prepared pursuant to accounting principles generally accepted in the U.S. (“GAAP”) as promulgated by the Financial Accounting Standards Board (“FASB”). References herein to GAAP are to topics within the FASB Accounting Standards Codification (the “FASB ASC”), which the FASB periodically revises through the issuance of an Accounting Standards Update (“ASU”) and which has been established by the FASB as the authoritative source for GAAP recognized by the FASB to be applied by nongovernmental entities.
Reclassifications: The Company has classified certain prior year information to conform to the amounts presented in the current year. None of the changes impact the Company’s previously reported financial position or results of operations.
Fiscal Year: The Company's fiscal year ends on the Sunday nearest to or on March 31. References herein to “fiscal year 2020” or “2020” represent the 52-week period ended March 29, 2020 and references to “fiscal year 2019” or “2019” represent the 52-week period ended March 31, 2019.
Use of Estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated balance sheets and the reported amounts of revenues and expenses during the periods presented on the consolidated statements of income and cash flows. Significant estimates are made with respect to the allowances related to accounts receivable for customer deductions for returns, allowances and disputes. The Company also has a certain amount of discontinued finished goods which necessitates the establishment of inventory reserves that are highly subjective. Actual results could differ materially from those estimates.
Cash and Cash Equivalents: The Company’s credit facility consists of a revolving line of credit under a financing agreement with The CIT Group/Commercial Services, Inc. (“CIT”), a subsidiary of CIT Group Inc. The Company classifies a negative balance outstanding under this revolving line of credit as cash, as these amounts are legally owed to the Company and are immediately available to be drawn upon by the Company. There are no compensating balance requirements or other restrictions on the transfer of amounts associated with the Company’s depository accounts.
Financial Instruments: For short-term instruments such as cash and cash equivalents, accounts receivable and accounts payable, the Company uses carrying value as a reasonable estimate of fair value.
Segments and Related Information: The Company operates primarily in one principal segment, infant and toddler products. These products consist of infant and toddler bedding, bibs, soft bath products, disposable products, developmental and bath toys and accessories. Net sales of bedding, blankets and accessories and net sales of bibs, bath and disposable products for fiscal years ended March 29, 2020 and March 31, 2019 are as follows (in thousands):
Revenue Recognition: Revenue is recognized upon the satisfaction of all contractual performance obligations and the transfer of control of the products sold to the customer. The majority of the Company’s sales consists of single performance obligation arrangements for which the transaction price for a given product sold is equivalent to the price quoted for the product, net of any stated discounts applicable at a point in time. Each sales transaction results in an implicit contract with the customer to deliver a product as directed by the customer. Shipping and handling costs that are charged to customers are included in net sales, and the Company’s costs associated with shipping and handling activities are included in cost of products sold.
A provision for anticipated returns, which are based upon historical returns and claims, is provided through a reduction of net sales and cost of products sold in the reporting period within which the related sales are recorded. Actual returns and claims experienced in a future period may differ from historical experience, and thus, the Company’s provision for anticipated returns at any given point in time may be over-funded or under-funded.
The Company recognizes revenue associated with unredeemed store credits and gift certificates at the earlier of their redemption by customers, their expiration or when their likelihood of redemption becomes remote, which is generally two years from the date of issuance. Revenue from sales made directly to consumers is recorded when the shipped products have been received by customers, and excludes sales taxes collected on behalf of governmental entities. Revenue from sales made to retailers is recorded when legal title has been passed to the customer based upon the terms of the customer’s purchase order, the Company’s sales invoice, or other associated relevant documents. Such terms usually stipulate that legal title will pass when the shipped products are no longer under the control of the Company, such as when the products are picked up at the Company’s facility by the customer or by a common carrier. Payment terms can vary from prepayment for sales made directly to consumers to payment due in arrears (generally, 60 days of being invoiced) for sales made to retailers.
Allowances Against Accounts Receivable: Revenue from sales made to retailers is reported net of allowances for anticipated returns and other allowances, including cooperative advertising allowances, warehouse allowances, placement fees, volume rebates, coupons and discounts. Such allowances are recorded commensurate with sales activity or using the straight-line method, as appropriate, and the cost of such allowances is netted against sales in reporting the results of operations. The provision for the majority of the Company’s allowances occurs on a per-invoice basis. When a customer requests to have an agreed-upon deduction applied against the customer’s outstanding balance due to the Company, the allowances are correspondingly reduced to reflect such payments or credits issued against the customer’s account balance. The Company analyzes the components of the allowances for customer deductions monthly and adjusts the allowances to the appropriate levels. The timing of funding requests for advertising support can cause the net balance in the allowance account to fluctuate from period to period. The timing of such funding requests should have no impact on the consolidated statements of income since such costs are accrued commensurate with sales activity or using the straight-line method, as appropriate.
Uncollectible Accounts: To reduce the exposure to credit losses and to enhance the predictability of its cash flows, the Company assigns the majority of its receivables under factoring agreements with CIT. In the event a factored receivable becomes uncollectible due to creditworthiness, CIT bears the risk of loss. The Company recognizes revenue net of the amount that is expected to be uncollectible on accounts receivable, if any, that are not assigned under the factoring agreements with CIT. The Company’s management makes estimates of the uncollectiblity of its non-factored accounts receivable by specifically analyzing the accounts receivable, historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in its customers’ payment terms.
Credit Concentration: The Company’s accounts receivable at March 29, 2020 amounted to $17.8 million, net of allowances of $530,000. Of this amount, $17.1 million was due from CIT under the factoring agreements, which amount represents the maximum loss that the Company could incur if CIT failed completely to perform its obligations under the factoring agreements. The Company’s accounts receivable at March 31, 2019 amounted to $17.8 million, net of allowances of $407,000. Of this amount, $17.3 million was due from CIT under the factoring agreements, which amount represented the maximum loss that the Company could have incurred if CIT failed completely to perform its obligations under the factoring agreements.
Other Accrued Liabilities: An amount of $352,000 was recorded as other accrued liabilities as of March 29, 2020. Of this amount, $155,000 reflected unearned revenue recorded for payments from customers that were received before the products ordered were received by the customers. Other accrued liabilities as of March 29, 2020 also includes a reserve for customer returns of $16,000 and unredeemed store credits and gift certificates totaling $8,000. An amount of $483,000 was recorded as other accrued liabilities as of March 31, 2019. Of this amount, $241,000 reflected unearned revenue recorded for payments from customers that were received before the products ordered were received by the customers. Other accrued liabilities as of March 31, 2019 also included a reserve for customer returns of $6,000 and unredeemed store credits and gift certificates totaling $19,000.
Inventory Valuation: The preparation of the Company's financial statements requires careful determination of the appropriate value of the Company's inventory balances. Such amounts are presented as a current asset in the accompanying consolidated balance sheets and are a direct determinant of cost of products sold in the accompanying consolidated statements of income and, therefore, have a significant impact on the amount of net income reported in the accounting periods. The basis of accounting for inventories is cost, which includes the direct supplier acquisition cost, duties, taxes and freight, and the indirect costs to design, develop, source and store the product until it is sold. Once cost has been determined, the Company’s inventory is then stated at the lower of cost or net realizable value, with cost determined using the first-in, first-out ("FIFO") method, which assumes that inventory quantities are sold in the order in which they are acquired, and the average cost method for a portion of the Company’s inventory.
The determination of the indirect charges and their allocation to the Company's finished goods inventories is complex and requires significant management judgment and estimates. If management made different judgments or utilized different estimates, then differences would result in the valuation of the Company's inventories and in the amount and timing of the Company's cost of products sold and the resulting net income for the reporting period.
On a periodic basis, management reviews its inventory quantities on hand for obsolescence, physical deterioration, changes in price levels and the existence of quantities on hand which may not reasonably be expected to be sold within the Company’s normal operating cycle. To the extent that any of these conditions is believed to exist or the market value of the inventory expected to be realized in the ordinary course of business is otherwise no longer as great as its carrying value, an allowance against the inventory value is established. To the extent that this allowance is established or increased during an accounting period, an expense is recorded in cost of products sold in the Company's consolidated statements of income. Only when inventory for which an allowance has been established is later sold or is otherwise disposed is the allowance reduced accordingly. Significant management judgment is required in determining the amount and adequacy of this allowance. In the event that actual results differ from management's estimates or these estimates and judgments are revised in future periods, the Company may not fully realize the carrying value of its inventory or may need to establish additional allowances, either of which could materially impact the Company's financial position and results of operations.
Royalty Payments: The Company has entered into agreements that provide for royalty payments based on a percentage of sales with certain minimum guaranteed amounts. These royalty amounts are accrued based upon historical sales rates adjusted for current sales trends by customers. Royalty expense is included in cost of products sold in the accompanying consolidated statements of income and amounted to $4.9 million and $5.2 million for fiscal years 2020 and 2019, respectively.
Depreciation and Amortization: The accompanying consolidated balance sheets reflect property, plant and equipment, and certain intangible assets at cost less accumulated depreciation or amortization. The Company capitalizes additions and improvements and expenses maintenance and repairs as incurred. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which are three to eight years for property, plant and equipment, and five to twenty years for intangible assets other than goodwill. The Company amortizes improvements to its leased facilities over the term of the lease or the estimated useful life of the asset, whichever is shorter.
Valuation of Long-Lived Assets and Identifiable Intangible Assets: In addition to the depreciation and amortization procedures set forth above, the Company reviews for impairment long-lived assets and certain identifiable intangible assets whenever events or changes in circumstances indicate that the carrying amount of any asset may not be recoverable. In the event of impairment, the asset is written down to its fair market value.
Patent Costs: The Company incurs certain legal and related costs in connection with patent applications. The Company capitalizes such costs to be amortized over the expected life of the patent to the extent that an economic benefit is anticipated from the resulting patent or an alternative future use is available to the Company. The Company also capitalizes legal and other costs incurred in the protection or defense of the Company’s patents when it is believed that the future economic benefit of the patent will be maintained or increased and a successful defense is probable. Capitalized patent defense costs are amortized over the remaining expected life of the related patent. The Company’s assessment of future economic benefit of its patents involves considerable management judgment, and a different conclusion could result in a material impairment charge up to the carrying value of these assets.
Leases: The Company capitalizes most of its operating lease obligations as right-of-use assets and recognizes corresponding liabilities. The Company elects to use the practical expedient that permits the Company to exclude short-term agreements of less than 12 months from capitalization. The Company is a party to various operating leases for offices, warehousing facilities and certain office equipment. The leases expire at various dates, have varying options to renew and cancel, and may contain escalation provisions. The Company recognizes as expense non-variable lease payments ratably over the lease term. The key estimates for the Company’s leases include the discount rate used to discount the unpaid lease payment to present value and the lease term. The Company’s leases generally do not include a readily determinable implicit rate; therefore, management determined the incremental borrowing rate to discount the lease payment based on the information available at lease commencement. For purposes of such estimates, a lease term includes the noncancellable period under the applicable lease.
Provision for Income Taxes: The Company’s provision for income taxes includes all currently payable federal, state, local and foreign taxes and is based upon the Company’s estimated annual effective tax rate, which is based on the Company’s forecasted annual pre-tax income, as adjusted for certain expenses within the consolidated statements of income that will never be deductible on the Company’s tax returns and certain charges expected to be deducted on the Company’s tax returns that will never be deducted on the consolidated statements of income, multiplied by the statutory tax rates for the various jurisdictions in which the Company operates and reduced by certain anticipated tax credits.
The Company files income tax returns in the many jurisdictions in which it operates, including the U.S., several U.S. states and the People’s Republic of China. The statute of limitations varies by jurisdiction; tax years open to federal or state audit or other adjustment as of March 29, 2020 were the tax years ended March 29, 2020, March 31, 2019, April 1, 2018, April 2, 2017, April 3, 2016, March 29, 2015 and March 30, 2014.
Management evaluates items of income, deductions and credits reported on the Company’s various federal and state income tax returns filed and recognizes the effect of positions taken on those income tax returns only if those positions are more likely than not to be sustained. The Company applies the provisions of accounting guidelines that require a minimum recognition threshold that a tax benefit must meet before being recognized in the financial statements. Recognized income tax positions are measured at the largest amount that has a greater than 50% likelihood of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
After considering all relevant information regarding the calculation of the state portion of its income tax provision, the Company believes that the technical merits of the tax position that the Company has taken with respect to state apportionment percentages would more likely than not be sustained. However, the Company also realizes that the ultimate resolution of such tax position could result in a tax charge that is more than the amount realized based upon the application of the tax position taken. Therefore, the Company’s measurement regarding the tax impact of the revised state apportionment percentages resulted in the Company recording discrete reserves for unrecognized tax liabilities during fiscal years 2020 and 2019 of $58,000 and $87,000, respectively, in the accompanying consolidated statements of income.
The Company’s policy is to accrue interest expense and penalties as appropriate on any estimated unrecognized tax liabilities as a charge to interest expense in the Company’s consolidated statements of income. During fiscal years 2020 and 2019, the Company accrued $76,000 and $90,000, respectively, for interest expense and penalties on the portion of the unrecognized tax liabilities that has been refunded to the Company but for which the relevant statute of limitations remained unexpired. No interest expense or penalties are accrued with respect to estimated unrecognized tax liabilities that are associated with state income tax overpayments that remain receivable.
In December 2016, the Company was notified by the Franchise Tax Board of the State of California (the “FTB”) of its intention to examine the Company’s claims for refund made in connection with amended consolidated income tax returns that the Company had filed for the fiscal years ended March 30, 2014, March 31, 2013, April 1, 2012 and April 3, 2011. On July 31, 2019, the FTB notified the Company that it would take no further action with regard to the fiscal years ended March 31, 2013, April 1, 2012 and April 3, 2011. In addition, on January 7, 2020, the Company’s California consolidated income tax return for the fiscal year ended March 29, 2015 became closed to examination or other adjustment. Accordingly, the Company reversed the reserves for unrecognized tax liabilities that it had previously recorded for these fiscal years, which resulted in the recognition of a discrete income tax benefit of $444,000 during the fiscal year ended March 29, 2020 in the accompanying consolidated statements of income. The Company also reversed the interest expense and penalties that it had accrued in respect of the unrecognized tax liabilities for these fiscal years, which resulted in the recognition of a credit to interest expense of $163,000 during the fiscal year ended March 29, 2020.
As of April 20, 2020, the status of the Company’s claim for refund made in connection with the amended consolidated income tax return that the Company filed for the fiscal year ended March 30, 2014 was not resolved. The ultimate resolution of this claim for refund could include administrative or legal proceedings. Although management believes that the calculations and positions taken on the amended consolidated income tax return and all other filed income tax returns are reasonable and justifiable, the outcome of this or any other examination could result in an adjustment to the position that the Company took on such income tax returns. Such adjustment could also lead to adjustments to one or more other state income tax returns, or to income tax returns for subsequent fiscal years, or both. To the extent that the Company’s reserve for unrecognized tax liabilities is not adequate to support the cumulative effect of such adjustments, the Company could experience a material adverse impact on its future results of operations. Conversely, to the extent that the calculations and positions taken by the Company on the filed income tax returns under examination are sustained, another reversal of all or a portion of the Company’s reserve for unrecognized tax liabilities could result in a favorable impact on its future results of operations.
During the fiscal year ended March 29, 2020, the Company recorded a discrete income tax benefit of $274,000 to reflect the aggregate effect of certain tax credits claimed on amended and original consolidated federal income tax returns.
During the fiscal years ended March 29, 2020 and March 31, 2019, the Company recorded discrete income tax charges of $5,000 and $12,000, respectively, to reflect the 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.
Advertising Costs: The Company’s advertising costs are primarily associated with cooperative advertising arrangements with certain of the Company’s customers and are recognized using the straight-line method based upon aggregate annual estimated amounts for these customers, with periodic adjustments to the actual amounts of authorized agreements. Costs associated with advertising on websites such as Facebook and Google and which are associated with the Company’s online business are recorded as incurred. Advertising expense is included in other marketing and administrative expenses in the consolidated statements of income and amounted to $1.1 million and $1.3 million for fiscal years 2020 and 2019, respectively.
Earnings Per Share: The Company calculates basic earnings per share by using a weighted average of the number of shares outstanding during the reporting periods. Diluted shares outstanding are calculated in accordance with the treasury stock method, which assumes that the proceeds from the exercise of all exercisable options would be used to repurchase shares at market value. The net number of shares issued after the exercise proceeds are exhausted represents the potentially dilutive effect of the exercisable options, which are added to basic shares to arrive at diluted shares.
Recently-Issued Accounting Standards: On February 25, 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which was intended to increase transparency and comparability by requiring an entity to recognize lease assets and lease liabilities on its balance sheet and by requiring the disclosure of key information about its leasing arrangements. Upon adoption, the Company was required under the provisions of ASU No. 2016-02 to capitalize most of its current operating lease obligations as right-of-use assets with corresponding liabilities based upon the present value of the future cash outflows associated with such operating lease obligations. The ASU was required to be adopted effective for the first interim period of the fiscal year beginning after December 15, 2018.
When issued, ASU No. 2016-02 was to have been applied using a modified retrospective approach, but on July 30, 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which allowed for an alternative optional transition method with which to adopt ASU No. 2016-02. Upon adoption, in lieu of the modified retrospective approach, an entity was allowed to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.
Although early adoption of ASU No. 2016-02 (as modified by ASU No. 2018-11) was permitted, the Company adopted the ASU effective as of April 1, 2019. ASU No. 2016-02 contains a number of optional practical expedients available to be used in transition. The Company elected to use the “package of practical expedients,” which permitted the Company to avoid a reassessment of prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected to use the practical expedient that permits the Company to exclude short-term agreements of less than 12 months from capitalization. The Company used the modified retrospective approach upon the adoption of ASU No. 2016-02, which resulted in the recognition by the Company of operating lease liabilities and corresponding right-of-use assets of $1.9 million based on the present value of the then-remaining minimum rental payments under the Company’s operating leases.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, the objective of which is to provide financial statement users with more information about the expected credit losses on financial instruments and other commitments to extend credit held by an entity. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable that a loss has been incurred. Because this methodology restricted the recognition of credit losses that are expected, but did not yet meet the “probable” threshold, ASU No. 2016-13 was issued to require the consideration of a broader range of reasonable and supportable information when determining estimates of credit losses.
ASU No. 2016-13 is to be applied using a modified retrospective approach, and the ASU could have been early-adopted in the fiscal year that began after December 15, 2018. When issued, ASU No. 2016-13 was required to be adopted no later than the fiscal year beginning after December 15, 2019, but on November 15, 2019, the FASB issued ASU No. 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates, which provided for the deferral of the effective date of ASU No. 2016-13 for registrants that are a smaller reporting company to the first interim period of the fiscal year beginning after December 15, 2022. Accordingly, the Company intends to adopt ASU No. 2016-13 effective as of April 3, 2023. Although the Company has not determined the full impact of the adoption of ASU No. 2016-13, because the Company assigns the majority of its trade accounts receivable under factoring agreements with CIT, the Company does not believe that the adoption of the ASU will have a significant impact on the Company’s financial position, results of operations and related disclosures.
The Company has determined that all other ASU’s issued which had become effective as of April 20, 2020, or which will become effective at some future date, are not expected to have a material impact on the Company’s consolidated financial statements.
Note 3 - Financing Arrangements
Factoring Agreements: To reduce its exposure to credit losses, The Company assigns the majority of its trade accounts receivable to CIT pursuant to factoring agreements, which have expiration dates that are coterminous with that of the financing agreement described below. Under the terms of the factoring agreements, CIT remits customer payments to the Company as such payments are received by CIT.
CIT bears credit losses with respect to assigned accounts receivable from approved shipments, 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 occurs, the Company either assumes (and may seek to mitigate) the credit risk for shipments to the customer after the date of such termination or limitation or discontinues shipments to the customer. Factoring fees, which are included in marketing and administrative expenses in the accompanying consolidated statements of income, were $255,000 and $261,000 during fiscal years 2020 and 2019, respectively. There were no advances on the factoring agreements at March 29, 2020 or March 31, 2019.
Credit Facility: The Company’s credit facility at March 29, 2020 consisted of a revolving line of credit under a financing agreement with CIT of up to $26.0 million, which includes a $1.5 million sub-limit for letters of credit, bearing interest at the rate of prime minus 0.5% or LIBOR plus 1.75%. The financing agreement matures on July 11, 2022 and is secured by a first lien on all assets of the Company. At March 29, 2020, the Company had elected to pay interest on balances owed under the revolving line of credit under the LIBOR option, which was 3.27% as of March 29, 2020. The financing agreement also provides for the payment by CIT to the Company of interest at the rate of prime as of the beginning of the calendar month minus 2.0%, which was 2.75% as of March 29, 2020, on daily negative balances, if any, held by CIT.
As of March 29, 2020, there was a balance of $2.6 million owed on the revolving line of credit, there was no letter of credit outstanding and $20.1 million was available under the revolving line of credit based on the Company’s eligible accounts receivable and inventory balances. As of March 31, 2019, there was a balance of $4.5 million owed on the revolving line of credit, there was no letter of credit outstanding and $19.4 million was available under the revolving line of credit based on the Company’s eligible accounts receivable and inventory balances.
The financing agreement contains usual and customary covenants for agreements of that type, including limitations on other indebtedness, liens, transfers of assets, investments and acquisitions, merger or consolidation transactions, transactions with affiliates, and changes in or amendments to the organizational documents for the Company and its subsidiaries. The Company believes it was in compliance with these covenants as of March 29, 2020.
Note 4 - Leases
Effective as of April 1, 2019, the Company commenced its initial application of the provisions of FASB ASC Topic 842, Leases (“Topic 842”), under which the Company has capitalized most of its current operating lease obligations as right-of-use assets and recognized corresponding liabilities. The Company has used a modified retrospective transition approach permitted by Topic 842. The Company elected to use the “package of practical expedients,” which permitted the Company to avoid a reassessment of prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected the practical expedient that permitted the Company to exclude short-term agreements of less than 12 months from capitalization.
In its initial application of Topic 842, the Company recognized operating lease liabilities and corresponding right-of-use assets of $1.9 million based on the present value of the then-remaining minimum rental payments under the Company’s operating leases. In addition to the recognition of operating lease liabilities and right-of-use assets, the Company also reclassified its deferred rent liability as of April 1, 2019 of $99,000 as an offset to the amount of its initial operating lease right-of-use assets. The Company was not required to recognize a cumulative-effect adjustment to the opening balance of the Company’s retained earnings as a result of the initial application of Topic 842.
The Company is a party to various operating leases for offices, warehousing facilities and certain office equipment. The leases expire at various dates, have varying options to renew and cancel, and may contain escalation provisions. The Company recognizes as expense non-variable lease payments ratably over the lease term. The key estimates for the Company’s leases include the discount rate used to discount the unpaid lease payment to present value and the lease term. The Company’s leases generally do not include a readily determinable implicit rate; therefore, management determined the incremental borrowing rate to discount the lease payment based on the information available at lease commencement. For purposes of such estimates, a lease term includes the noncancellable period under the applicable lease.
Subsequent to the Company’s recognition of operating lease liabilities of $1.9 million on April 1, 2019, the Company made cash payments related to its recognized operating leases of $1.4 million during the fiscal year ended March 29, 2020. Such payments reduced the operating lease liabilities and were included in the cash flows provided by operating activities in the accompanying consolidated statements of cash flows.
During the fiscal year ended March 29, 2020, the Company classified its operating lease costs within the accompanying consolidated statements of income as follows (in thousands):
The Company’s operating leases have a weighted-average remaining lease term of 3.0 years. The weighted-average discount rate for the operating leases is 3.82%. The following table represents the maturities of the Company’s operating lease liabilities as of March 29, 2020 (in thousands):
The following table represents the Company’s commitment for minimum guaranteed rental payments under its lease agreements as of March 31, 2019 (in thousands):
Note 5 - Retirement Plan
The Company sponsors a defined contribution retirement savings plan with a cash or deferred arrangement (the “401(k) Plan”), as provided by Section 401(k) of the Internal Revenue Code (“Code”). The 401(k) Plan covers substantially all employees, who may elect to contribute a portion of their compensation to the 401(k) Plan, subject to maximum amounts and percentages as prescribed in the Code. Each calendar year, the Company’s Board of Directors (the “Board”) determines the portion, if any, of employee contributions that will be matched by the Company. For calendar years 2020, 2019 and 2018, the Board established the employer matching contributions at 100% of the first 2% of employee contributions and 50% of the next 3% of employee contributions to the 401(k) Plan. If an employee separates from the Company prior to the full vesting of the funds in their account, then the unvested portion of the matching employer amount in their account is forfeited when the employee receives a distribution from their account. The Company utilizes such forfeitures as an offset to the aggregate matching contributions. The Company's matching contributions to the 401(k) Plan, net of the utilization of forfeitures, were $291,000 and $284,000 for fiscal years 2020 and 2019, respectively.
Note 6 - Goodwill, Customer Relationships and Other Intangible Assets
Goodwill: Goodwill represents the excess of the purchase price over the fair value of net identifiable assets acquired in business combinations. For the purpose of presenting and measuring for the impairment of goodwill, the Company has two reporting units: one that produces and markets infant and toddler bedding, blankets and accessories and another that produces and markets infant and toddler bibs, developmental toys, bath care and disposable products. The goodwill of the reporting units of the Company as of March 29, 2020 and March 31, 2019 amounted to $30.0 million, which is reflected in the accompanying consolidated balance sheets net of accumulated impairment charges of $22.9 million, for a net reported balance of $7.1 million.
The Company measures for impairment the goodwill within its reporting units annually as of the first day of the Company’s fiscal year. An additional interim measurement for impairment is performed during the year whenever an event or change in circumstances occurs that suggests that the fair value of either of the reporting units of the Company has more likely than not (defined as having a likelihood of greater than 50%) fallen below its carrying value. The annual or interim measurement for impairment is performed by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If such qualitative factors so indicate, then the measurement for impairment is continued by calculating an estimate of the fair value of each reporting unit and comparing the estimated fair value to the carrying value of the reporting unit. If the carrying value exceeds the estimated fair value of the reporting unit, then an impairment charge is calculated as the difference between the carrying value of the reporting unit and its estimated fair value, not to exceed the goodwill of the reporting unit.
On April 1, 2019, the Company performed the annual measurement for impairment of the goodwill of its reporting units and concluded that the estimated fair value of each of the Company’s reporting units exceeded their carrying values, and thus the goodwill of the Company’s reporting units was not impaired as of that date.
Other Intangible Assets: Other intangible assets as of March 29, 2020 and March 31, 2019 consisted primarily of the fair value of identifiable assets acquired in business combinations other than tangible assets and goodwill. The gross amount and accumulated amortization of the Company’s other intangible assets as of March 29, 2020 and March 31, 2019, the amortization expense for fiscal years 2020 and 2019 and the classification of such amortization expense within the accompanying consolidated statements of income are as follows (in thousands):
The Company estimates that its amortization expense will be $790,000, $765,000, $689,000, $665,000 and $600,000 in fiscal years 2021, 2022, 2023, 2024 and 2025, respectively.
Note 7 - Inventories
Major classes of inventory were as follows (in thousands):
Note 8 - Stock-based Compensation
The Company has two incentive stock plans, the 2006 Omnibus Incentive Plan (the “2006 Plan”) and the 2014 Omnibus Equity Compensation Plan (the “2014 Plan”). As a result of the approval of the 2014 Plan by the Company’s stockholders at the Company’s 2014 annual meeting, grants may no longer be issued under the 2006 Plan.
The Company believes that awards of long-term, equity-based incentive compensation will attract and retain directors, officers and employees of the Company and will encourage these individuals to contribute to the successful performance of the Company, which will lead to the achievement of the Company’s overall goal of increasing stockholder value. Awards granted under the 2014 Plan may be in the form of incentive stock options, non-qualified stock options, shares of restricted or unrestricted stock, stock units, stock appreciation rights, or other stock-based awards. Awards may be granted subject to the achievement of performance goals or other conditions, and certain awards may be payable in stock or cash, or a combination of the two. The 2014 Plan is administered by the Compensation Committee of the Board, which selects eligible employees, non-employee directors and other individuals to participate in the 2014 Plan and determines the type, amount, duration (such duration not to exceed a term of ten (10) years for grants of options) and other terms of individual awards. At March 29, 2020, 440,000 shares of the Company’s common stock were available for future issuance under the 2014 Plan, which may be issued from authorized and unissued shares of the Company’s common stock or treasury shares.
Stock-based compensation is calculated according to FASB ASC Topic 718, Compensation - Stock Compensation, which requires stock-based compensation to be accounted for using a fair-value-based measurement. During fiscal years 2020 and 2019, the Company recorded $297,000 and $377,000 of stock-based compensation, respectively. The Company records the compensation expense associated with stock-based awards granted to individuals in the same expense classifications as the cash compensation paid to those same individuals. No stock-based compensation costs were capitalized as part of the cost of an asset as of March 29, 2020.
Stock Options: The following table represents stock option activity for fiscal years 2020 and 2019:
As of March 29, 2020, none of the outstanding or exercisable stock options held any intrinsic value. The Company did not receive any cash from the exercise of stock options during fiscal year 2020. Upon the exercise of stock options, participants may choose to surrender to the Company those shares from the option exercise necessary to satisfy the exercise amount and their income tax withholding obligations that arise from the option exercise. The effect on the cash flow of the Company from these “cashless” option exercises is that the Company remits cash on behalf of the participant to satisfy his or her income tax withholding obligations. The Company used cash to remit the required income tax withholding amounts from “cashless” option exercises of $3,000 during fiscal year 2020. There were no stock options exercised during fiscal year 2019. As of March 31, 2019, the intrinsic value of the outstanding and exercisable stock options was each $2,000.
To determine the estimated fair value of stock options granted, the Company uses the Black-Scholes-Merton valuation formula, which is a closed-form model that uses an equation to estimate fair value. The following table sets forth the assumptions used to determine the fair value of the non-qualified stock options awarded to certain employees during fiscal years 2020 and 2019, which options vest over a two-year period, assuming continued service.
For the fiscal years ended March 29, 2020 and March 31, 2019, the Company recognized compensation expense associated with stock options as follows (in thousands):
A summary of stock options outstanding and exercisable as of March 29, 2020 is as follows:
As of March 29, 2020, total unrecognized stock-option compensation costs amounted to $37,000, which will be recognized as the underlying stock options vest over a weighted-average period of 6.9 months. The amount of future stock-option compensation expense could be affected by any future stock option grants and by the separation from the Company of any employee or director who has stock options that are unvested as of such individual’s separation date.
Non-vested Stock Granted to Non-Employee Directors: The Board granted the following shares of non-vested stock to the Company’s non-employee directors:
These shares vest over a two-year period, assuming continued service. The fair value of non-vested stock granted to the Company’s non-employee directors was based on the closing price of the Company’s common stock on the date of each grant. In each of August 2019 and 2018, 28,000 shares that had been granted to the Company’s non-employee directors vested, having an aggregate value of $135,000 and $151,000, respectively.
Non-vested Stock Granted to Employees: On January 18, 2019, upon the appointment of Donna Sheridan to serve as the President and Chief Executive Officer of NoJo, the Board granted 25,000 shares of non-vested stock to Ms. Sheridan. These shares will vest on January 18, 2021, assuming continued service. The fair value of the non-vested stock granted to Ms. Sheridan is $5.86 per share, which was based on the closing price of the Company’s common stock on the date of the grant.
Performance Bonus Plan: The Company maintains a performance bonus plan for certain executive officers that provides for awards of cash or shares of common stock in the event that the aggregate average market value of the common stock during the relevant fiscal year, plus the amount of cash dividends paid in respect of the common stock during such period, increases. These individuals may instead be awarded cash, if and to the extent that an insufficient number of shares of common stock are available for issuance from all shareholder-approved, equity-based plans or programs of the Company in effect. The performance bonus plan also imposes individual limits on awards and provides that shares of common stock that may be awarded will vest over a two-year period. Thus, compensation expense associated with performance bonus plan awards are recognized over a three-year period - the fiscal year in which the award is earned, plus the two-year vesting period.
No shares were granted in fiscal years 2020 or 2019 in connection with the performance bonus plan. The Company recorded compensation expense during fiscal year 2019 of $116,000 related to shares granted in fiscal year 2018 that were earned in fiscal year 2017.
The table below sets forth the vesting of shares granted under the performance bonus plan, as well as the number of shares surrendered to the Company to satisfy the income tax withholding obligations that arose from the vesting of the shares and the taxes remitted to the appropriate taxing authorities on behalf of such individuals.
For the fiscal years ended March 29, 2020 and March 31, 2019, the Company recognized compensation expense associated with non-vested stock grants, which is included in marketing and administrative expenses in the accompanying consolidated statements of income, as follows (in thousands):
As of March 29, 2020, total unrecognized compensation expense related to the Company’s non-vested stock grants was $246,000, which will be recognized over the remaining portion of the respective vesting periods associated with each block of grants, such grants having a weighted average vesting term of 9.3 months. The amount of future compensation expense related to non-vested stock grants could be affected by any future non-vested stock grants and by the separation from the Company of any individual who has unvested grants as of such individual’s separation date.
Note 9 - Income Taxes
The Company’s income tax provision for the fiscal years ended March 29, 2020 and March 31, 2019 is summarized below (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of March 29, 2020 and March 31, 2019 are as follows (in thousands):
In assessing the probability that the Company’s deferred tax assets will be realized, management of the Company has considered whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of taxable income during the future periods in which the temporary differences giving rise to the deferred tax assets will become deductible. The Company has also considered the scheduled inclusion into taxable income in future periods of the temporary differences giving rise to the Company’s deferred tax liabilities. The valuation allowance as of March 29, 2020 and March 31, 2019 was related to state net operating loss carryforwards that the Company does not expect to be realized. Based upon the Company’s expectations of the generation of sufficient taxable income during future periods, the Company believes that it is more likely than not that the Company will realize its deferred tax assets, net of the valuation allowance and the deferred tax liabilities.
Management evaluates items of income, deductions and credits reported on the Company’s various federal and state income tax returns filed and recognizes the effect of positions taken on those income tax returns only if those positions are more likely than not to be sustained. The Company applies the provisions of accounting guidelines that require a minimum recognition threshold that a tax benefit must meet before being recognized in the financial statements. Recognized income tax positions are measured at the largest amount that has a greater than 50% likelihood of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
The following table sets forth the reconciliation of the beginning and ending amounts of unrecognized tax liabilities for fiscal years 2020 and 2019 (in thousands):
After considering all relevant information regarding the calculation of the state portion of its income tax provision, the Company believes that the technical merits of the tax position that the Company has taken with respect to state apportionment percentages would more likely than not be sustained. However, the Company also realizes that the ultimate resolution of such tax position could result in a tax charge that is more than the amount realized based upon the application of the tax position taken. Therefore, the Company’s measurement regarding the tax impact of the revised state apportionment percentages resulted in the Company recording discrete reserves for unrecognized tax liabilities during fiscal years 2020 and 2019 of $58,000 and $87,000, respectively, in the accompanying consolidated statements of income.
The Company’s policy is to accrue interest expense and penalties as appropriate on any estimated unrecognized tax liabilities as a charge to interest expense in the Company’s consolidated statements of income. During fiscal years 2020 and 2019, the Company accrued $76,000 and $90,000, respectively, for interest expense and penalties on the portion of the unrecognized tax liabilities that has been refunded to the Company but for which the relevant statute of limitations remained unexpired. No interest expense or penalties are accrued with respect to estimated unrecognized tax liabilities that are associated with state income tax overpayments that remain receivable.
In December 2016, the Company was notified by the FTB of its intention to examine the Company’s claims for refund made in connection with amended consolidated income tax returns that the Company had filed for the fiscal years ended March 30, 2014, March 31, 2013, April 1, 2012 and April 3, 2011. On July 31, 2019, the FTB notified the Company that it would take no further action with regard to the fiscal years ended March 31, 2013, April 1, 2012 and April 3, 2011. In addition, on January 7, 2020, the Company’s California consolidated income tax return for the fiscal year ended March 29, 2015 became closed to examination or other adjustment. Accordingly, the Company reversed the reserves for unrecognized tax liabilities that it had previously recorded for these fiscal years, which resulted in the recognition of a discrete income tax benefit of $444,000 during the fiscal year ended March 29, 2020 in the accompanying consolidated statements of income. The Company also reversed the interest expense and penalties that it had accrued in respect of the unrecognized tax liabilities for these fiscal years, which resulted in the recognition of a credit to interest expense of $163,000 during the fiscal year ended March 29, 2020.
As of April 20, 2020, the status of the Company’s claim for refund made in connection with the amended consolidated income tax return that the Company filed for the fiscal year ended March 30, 2014 was not resolved. The ultimate resolution of this claim for refund could include administrative or legal proceedings. Although management believes that the calculations and positions taken on the amended consolidated income tax return and all other filed income tax returns are reasonable and justifiable, the outcome of this or any other examination could result in an adjustment to the position that the Company took on such income tax returns. Such adjustment could also lead to adjustments to one or more other state income tax returns, or to income tax returns for subsequent fiscal years, or both. To the extent that the Company’s reserve for unrecognized tax liabilities is not adequate to support the cumulative effect of such adjustments, the Company could experience a material adverse impact on its future results of operations. Conversely, to the extent that the calculations and positions taken by the Company on the filed income tax returns under examination are sustained, another reversal of all or a portion of the Company’s reserve for unrecognized tax liabilities could result in a favorable impact on its future results of operations.
During the fiscal year ended March 29, 2020, the Company recorded a discrete income tax benefit of $274,000 to reflect the aggregate effect of certain tax credits claimed on amended and original consolidated federal income tax returns.
During the fiscal years ended March 29, 2020 and March 31, 2019, the Company recorded discrete income tax charges of $5,000 and $12,000, respectively, to reflect the 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 Company's provision for income taxes is based upon effective tax rates of 15.5% and 26.1% in fiscal years 2020 and 2019, respectively. These effective tax rates are the sum of the top U.S. statutory federal income tax rate and a composite rate for state income taxes, net of federal tax benefit, in the various states in which the Company operates, plus the net effect of various discrete items.
The following table reconciles income tax expense on income from continuing operations at the U.S. federal income tax statutory rate to the net income tax provision reported for fiscal years 2020 and 2019 (in thousands):
Note 10 - Shareholders’ Equity
Dividends: The holders of shares of the Company’s common stock are entitled to receive dividends when and as declared by the Board. Aggregate cash dividends of $0.57 and $0.32 per share, amounting to $5.8 million and $3.2 million, were declared during fiscal years 2020 and 2019, respectively. Cash dividends declared during fiscal year 2020 included a special cash dividend of $0.25 per share. The Company’s financing agreement with CIT permits the payment by the Company of cash dividends on its common stock without limitation, provided there is no default before or as a result of the payment of such dividends.
Stock Repurchases: The Company acquired treasury shares by way of the surrender to the Company from several employees shares of common stock to satisfy the income tax withholding obligations relating to the vesting of stock. In this manner, the Company acquired 12,000 treasury shares during the fiscal year ended March 29, 2020 at a weighted-average market value of $6.63 per share and acquired 16,000 treasury shares during the fiscal year ended March 31, 2019 at a weighted-average market value of $5.87 per share.
Note 11 - Major Customers
The table below sets forth those customers that represented more than 10% of the Company’s gross sales during fiscal years ended March 29, 2020 and March 31, 2019.
* Amount represented less than 10% of the Company's gross sales for this fiscal year.
Note 12 - Commitments and Contingencies
Total royalty expense amounted to $4.9 million and $5.2 million for fiscal years 2020 and 2019, respectively. The Company’s commitment for minimum guaranteed royalty payments under its license agreements as of March 29, 2020 is $4.2 million, consisting of $2.6 million, $1.6 million and $8,000 due in fiscal years 2021, 2022 and 2023, respectively.
The Company is, from time to time, involved in various legal proceedings relating to claims arising in the ordinary course of its business. Neither the Company nor any of its subsidiaries is a party to any such legal proceeding the outcome of which, individually or in the aggregate, is expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Note 13 - Subsequent Events
In late January 2020, the Company began to monitor the global effects of “COVID-19,” an infectious disease caused by Severe Acute Respiratory Syndrome Coronavirus 2 (SARS CoV-2) that was first detected in November 2019 in the city of Wuhan, China.
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security (the “CARES Act”), which, among other things, outlines the provisions of the Paycheck Protection Program (the “PPP”). The Company determined that it met the criteria to be eligible to obtain a loan under the PPP because, among other reasons, in light of COVID-19 outbreak and the uncertainty of economic conditions related thereto, the loan was necessary to support the Company’s ongoing operations. Under the PPP, the Company could obtain a U.S. Small Business Administration loan in an amount equal to the average of the Company’s monthly payroll costs (as defined under the PPP) for calendar 2019 multiplied by 2.5 (approximately 10 weeks of payroll costs). Section 1106 of the CARES Act contains provisions for the forgiveness of all or a portion of a PPP loan, subject to the satisfaction of certain requirements. The amount eligible for forgiveness is, subject to certain limitations, the sum of the Company’s payroll costs, rent and utilities paid by the Company during the eight-week period beginning on the funding date of the PPP loan.
On April 19, 2020, the Company closed on a PPP loan in the amount of $1,963,800, which was funded on April 20, 2020 and which was transferred by the Company into an account dedicated to allowable uses of the PPP loan proceeds.
The Company has evaluated events that have occurred between March 29, 2020 and the date that the accompanying financial statements were issued, and has determined that there are no other material subsequent events that require disclosure.