PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CROWN CRAFTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE-MONTHSIX-MONTH PERIODS ENDED DECEMBERSEPTEMBER 29, 2019 AND SEPTEMBER 30, 2018 AND DECEMBER 31, 2017

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 condensed consolidated balance sheets and are a direct determinant of cost of products sold in the accompanying unaudited condensed consolidated statements of income and, therefore, have a significant impact on the amount of net income reported in the accounting periods reported.periods. The basis of accounting for inventories is cost, which includes the direct supplier acquisition cost, duties, taxes and freight, and the indirect costs incurred to design, develop, source and store the productsproduct until they areit 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-outfirst-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’sCompany's finished goods inventory are determined as a percentageinventories 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 projected annual supplier purchasesthe Company's inventories and can impactin the Company’s resultsamount and timing of operations as purchase volumes fluctuate from quarter to quarter and year to year. The difference between indirect costs incurredthe Company's cost of products sold and the indirect costs allocated to inventory creates a burden variance, which is generally favorable when actual inventory purchases exceed planned inventory purchases, and is generally unfavorable when actual inventory purchases are lower than planned inventory purchases.resulting net income for the reporting period.

On a periodic basis, management reviews the Company’sits 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 of the Company's operations.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, of is the allowance reduced accordingly. Significant managementManagement judgment is required in determining the amount and adequacy of this allowance. In the event thatIf actual results differ from management's estimates or these estimates and judgments are revised in future periods, then 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 royaltiesroyalty 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 unaudited condensed consolidated statements of income and amounted to $1.3$1.3 million and $1.8$1.4 million for the three months ended DecemberSeptember 29, 2019 and September 30, 2018, and December 31, 2017, respectively, and amounted to $3.7$2.2 million and $5.0$2.4 million for the ninesix months ended DecemberSeptember 29, 2019 and September 30, 2018 and December 31, 2017, respectively.2018.

Depreciation and Amortization: The accompanying condensed 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 amortizable intangible assets.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: 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 associatedrelated costs in connection with applications for patents, which are classified within other finite-lived intangible assets in the accompanying condensed consolidated balance sheets.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 for the underlying product is available to the Company. The Company also capitalizes legal and other costs incurred in the protection or defense of the Company’s patents to the extent thatwhen it is believed that the future economic benefit of the patent will be maintained or increased and a successful outcome of the litigationdefense is probable. Capitalized patent protection or defense costs are amortized over the remaining expected life of the related patent. The Company’s assessment of the 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.

Purchase Price Allocations and the Resulting Goodwill: The Company’s strategy includes, when appropriate, entering into transactions accounted for as business combinations. In connection with a business combination, the Company prepares an allocation of the cost of the acquisition to the identifiable assets acquired and liabilities assumed, based on estimated fair values as of the acquisition date. The excess of the purchase price over the estimated fair value of the identifiable net assets acquired is recorded as goodwill.

The amount of goodwill recorded in a business combination can vary significantly depending upon the values attributed to the assets acquired and liabilities assumed. Although goodwill has no useful life and is not subject to a systematic annual amortization against earnings, the Company performs a measurement for impairment of the carrying value of its goodwill annually on the first day of the Company’s fiscal year. An additional impairment test is performed during the year whenever an event or change in circumstances suggest that the fair value of the goodwill of either of the reporting units of the Company has more likely than not fallen below its carrying value. The annual or interim measurement for impairment of goodwill is performed at the reporting unit level. A reporting unit is either an operating segment or one level below an operating segment. In its annual or interim measurement for impairment of goodwill, the Company conducts a qualitative assessment by examining relevant events and circumstances which could have a negative impact on the Company’s goodwill, which includes macroeconomic conditions, industry and market conditions, commodity prices, cost factors, overall financial performance, reporting unit dispositions and acquisitions, the market capitalization of the Company and other relevant events specific to the Company.

If, after assessing the totality of events or circumstances described above, the Company determines that it is more likely than not that the fair value of either of the Company’s reporting units is less than its carrying amount, then a quantitative goodwill test is performed. The quantitative goodwill impairment test is also performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If, after performing the quantitative goodwill test, it is determined that the carrying value of goodwill is impaired, the amount of goodwill is reduced and a corresponding charge is made to earnings in the period in which the goodwill is determined to be impaired.

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 (“ETR”), 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. The Company’s provisions for income taxes for the nine-monthsix-month periods ended DecemberSeptember 29, 2019 and September 30, 2018 and December 31, 2017 are based upon an estimated annual ETR from continuing operations of 24.2%24.0% and 33.0%, respectively.

The Company files income tax returns in the many jurisdictions within which it operates, including the U.S.23.4%, several U.S. states and the People’s Republic of China. The statute of limitations for the Company’s filed income tax returns varies by jurisdiction; tax years open to federal or state audit or other adjustment as of December 30, 2018 were the fiscal years ended April 1, 2018, April 2, 2017, April 3, 2016, March 29, 2015, March 30, 2014, March 31, 2013, April 1, 2012 and April 3, 2011.

On December 22, 2017, the President of the United States signed into law comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “TCJA”), which included a provision to lower the federal corporate income tax rate to 21% effective as of January 1, 2018. As the Company’s fiscal year 2018 ended on April 1, 2018, the lower corporate income tax rate was phased in, resulting in a blended federal statutory rate of 30.75% for fiscal year 2018.

respectively. The Company provides for deferred income taxes based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates that will be in effect when the differences are expected to reverse.

The Company’s policy is to recognize the effect that a change in enacted tax rates would have on net deferredCompany files income tax assets and liabilitiesreturns in the periodmany 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 September 29, 2019 were the tax rates are changed. The Company recognized the effect of the TCJA on the Company’s net deferred income tax assets, which had previously been recorded based upon the pre-TCJA enacted composite federal, stateyears ended March 31, 2019, April 1, 2018, April 2, 2017, April 3, 2016, March 29, 2015 and foreign income tax rate of approximately 37.5% that would have been applied as the financial statement and tax differences began to reverse. Because most of these differences are now expected to reverse at a composite rate of approximately 23.5%, the Company was required to revalue its net deferred income tax assets. This revaluation resulted in a discrete charge to income tax expense of $409,000 during the three and nine-month periods ended December 31, 2017.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 FASB ASC Sub-topic 740-10-25,740-10-25, which requires 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.

In evaluating the process regarding the calculation of the state portion of its income tax provision, the Company has taken a tax position that reflects opportunities for more favorable state apportionment percentages, which were then applied to several prior fiscal years and to succeeding fiscal years. After considering all relevant information, the Company believes that the technical merits of this tax position would more likely than not be sustained. However, the Company also believes that the ultimate resolution of the tax position will result in a tax benefit that is less than the full amount realized through the application of the more favorable state apportionment percentages. Therefore, the Company’s measurement regarding the tax impact of the revised state apportionment percentages has resulted in the Company recording a reservediscrete reserves for unrecognized tax benefitsliabilities of $7,000$31,000 and $31,000$56,000 during the three-monththree-month periods ended DecemberSeptember 29, 2019 and September 30, 2018, and December 31, 2017, respectively, and $66,000$42,000 and $60,000$59,000 during the nine-monthsix-month periods ended DecemberSeptember 29, 2019 and September 30, 2018, and December 31, 2017, respectively, in the accompanying unaudited condensed consolidated statements of income.

Because the tax impact of the revised state apportionment percentages are measured net of federal income taxes, the provision in the TCJA that lowered the federal corporate income tax rate to 21% required the Company to revalue its reserve for unrecognized tax benefits. This revaluation resulted in a net discrete charge to income tax expense of $132,000 during the three and nine-month periods ended December 31, 2017.

The Company’s policy is to accrue interest expense and penalties as appropriate on estimated unrecognized tax benefitsliabilities as a charge to interest expense in the Company’s consolidated statements of income. Interest expense and penalties are not accrued with respect to estimated unrecognized tax benefits that are associated with claims for income tax refunds as long as the overpayments are receivable. The Company accrued interest and penalties associated with its reserve for unrecognized tax benefits of $22,000 and $16,000liabilities during the three-monththree-month periods ended DecemberSeptember 29, 2019 and September 30, 2018 of $18,000 and December 31, 2017, $21,000, respectively, and $68,000 and $52,000during the nine-monthsix-month periods ended DecemberSeptember 29, 2019 and September 30, 2018 of $29,000 and $46,000, respectively, in the accompanying unaudited condensed consolidated statements of income for interest expense and penalties on the unrecognized tax liabilities 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, 2017, respectively,2013, April 1, 2012 and April 3, 2011. As outlined above, the Company has recorded discrete reserves for unrecognized tax liabilities for these and succeeding fiscal years, and has also accrued interest expense and penalties associated with these estimated unrecognized tax liabilities.

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. 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 $232,000 during the six-month period ended September 29, 2019 in the accompanying unaudited condensed consolidated statements of income. The revaluationCompany also reversed the interest expense and penalties that it had accrued in respect of the estimated unrecognized tax liabilities for these fiscal years, which resulted in the recognition of a credit to interest expense of $78,000 during the six-month period ended September 29, 2019.

As of October 25, 2019, 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 benefits set forth inliabilities is not adequate to support the preceding paragraph resulted in an additional accrual for interest and penalties with respectcumulative effect of such adjustments, the Company could experience a material adverse impact on its future results of operations. Conversely, to the revaluedextent 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 benefitsliabilities could result in a favorable impact on its future results of $25,000 during the three and nine-month periods ended December 31, 2017.operations.

During the nine-monththree-month periods ended DecemberSeptember 29, 2019 and September 30, 2018, and December 31, 2017, the Company recorded a discrete income tax chargecharges of $12,000$4,000 and a$17,000, respectively, to reflect the effect of the tax shortfalls arising from the vesting of non-vested stock during the periods. During the six-month periods ended September 29, 2019 and September 30, 2018, the Company recorded discrete income tax benefitcharges of $23,000,$6,000 and $12,000, respectively, to reflect the net effects of the tax shortfalls and the excess tax benefits arising from the vesting of non-vested stock during the periods.

The ETR on continuing operations and the discrete income tax charges and benefits set forth above resulted in an overall provision for income taxes of 25.8%18.8% and 49.7%26.0% for the nine-monthsix-month periods ended DecemberSeptember 29, 2019 and September 30, 2018, and December 31, 2017, 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:In 2014, the FASB issued Accounting Standards Update (“ASU”) No.2014-09,Revenue from Contracts with Customers (Topic 606), which has replaced most previous GAAP guidance on revenue recognition, and which now requires the use of more estimates and judgments. When issued, ASU No.2014-09 was to become effective in the fiscal year beginning after December 15,June 2016, but on August 12, 2015 the FASB issued ASU No.2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which provided for a one-year deferral of the effective date to apply the guidance of ASU No.2014-09. Thus, the Company adopted ASU No.2014-09 effective as of April 2, 2018 on a modified retrospective basis.

ASU No.2014-09 requires that revenue be recognized by an entity when a customer obtains control of promised products in an amount that reflects the consideration that the entity expects to receive in exchange for those products. A further description of the GAAP guidance in effect subsequent to the Company’s adoption of ASU No.2014-09 is set forth above under the headings “Revenue Recognition,” “Allowances Against Accounts Receivable” and “Uncollectible Accounts” in this Note 1 disclosure. The Company performed an evaluation of its revenue contract arrangements and determined that, although the disclosures related to the Company’s accounting policies and practices associated with the amount and timing of revenue recognition have been enhanced, the adoption of ASU No.2014-09 did not have a material effect on the Company’s financial position or results of operations.

On February 25, 2016, the FASB issued ASU No.2016-02,Leases (Topic 842), which will 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 leasing arrangements. Under the provisions of ASU No.2016-02, the Company will be required 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. ASU No.2016-02 will become 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 will allow an alternative optional transition method with which to adopt ASU No.2016-02. Upon adoption, in lieu of the modified retrospective approach, an entity will be 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) is permitted, the Company intends to adopt ASU No.2016-02 effective as of April 1, 2019. The Company has not yet decided whether it will use the modified retrospective approach or the cumulative-effect adjustment approach and is currently evaluating the effect that the adoption of ASU No.2016-02 will have on its financial position, results of operations and related disclosures.

On June 16, 2016, the FASB issued ASU No.2016-13, 2016-13, Financial Instruments – Credit Losses (Topic 326)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” threshhold,threshold, ASU No.2016-13 2016-13 was issued to require the consideration of a broader range of reasonable and supportable information when determining estimates of credit losses. The ASU will become effective for the first interim period of the fiscal year beginning after December 15, 2019. The ASU is to be applied using a modified retrospective approach, and the ASU may be early-adopted as of the first interim period of the fiscal year beginning after December 15, 2018.

The Company intends to adopt ASU No. 2016-13 effective as of March 30, 2020. Although the Company has not yet decided whether to adopt ASU No.2016-13 early or determined the full impact of the adoption of the ASU, because the Company assigns the majority of its trade accounts receivable under factoring agreements with CIT, the Company does not believe that itsthe adoption of the ASUNo.2016-13 will have a materialsignificant impact on the Company’s financial position, results of operations and related disclosures.

The Company has determined that all other ASUs which had become effective as of December 30, 2018, September 29, 2019, or which will become effective at some future date, are not expected to have a material impact on the Company’s consolidated financial statements.