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| SGC > SEC Filings for SGC > Form 10-K on 27-Feb-2009 | All Recent SEC Filings |
27-Feb-2009
Annual Report
OVERVIEW: In 2008, net sales increased by 2.7% in comparison to 2007 and in 2007, net sales decreased by 2.6% in comparison to 2006. The increase in net sales in 2008 was primarily attributed to several large new customer uniform programs that were distributed in 2008. The positive impact of these new programs was offset by softer demand from existing customers due to the current economic downturn occurring in the United States. Our customers are reducing employee counts as a result of the current environment and this is expected to continue to negatively impact sales results in 2009.
OPERATIONS: In 2008, net sales increased 2.7% in comparison to 2007. The increase in net sales is primarily attributed to several large new customer uniform programs that were distributed in 2008 offset by softer demand from existing customers. In 2007, net sales decreased 2.6% in comparison to 2006. The decrease in net sales was primarily attributed to the elimination of the uniform program at one of our major customers in the fourth quarter of 2006. This resulted in a decrease of approximately $2,917,000 in net sales for 2007. During 2007, we were awarded additional business from this customer that began shipping late in the second quarter. This resulted in net sales of approximately $1,422,000 in 2007. Additionally, demand from existing customers was lower than expected and more than offset the new business generated in 2007. The remainder of the decrease was attributed to customers lost as a result of the 2005 implementation of our new warehouse management system that resulted in disruptions to our service levels with customers during the first half of 2005. Certain of these lost customers were still winding down purchases from the Company during the first half of 2006.
As a percentage of sales, cost of goods sold was 67.4% in 2008, and 67.1% in 2007. The percentage increase in 2008 as compared to 2007 is primarily attributed to an increase in direct product costs as a percentage of sales (0.9%) offset by the impact of more efficient operations in our value added services area and spreading our overhead over higher net sales (-0.6%). The Company's gross margins may not be comparable with other entities, since some entities include all of the costs related to their distribution network in cost of goods sold. As disclosed in Note 1 to the consolidated financial statements, the Company includes a portion of the costs associated with its distribution network in selling and administrative expenses. The amounts included in selling and administrative expenses for each of the years ended December 31, 2008 and 2007, respectively, were $7,353,914, and $7,323,836.
As a percentage of sales, selling and administrative expenses were 27.7% in 2008 and 28.0% in 2007. The decrease in percentage in 2008 as compared to 2007 is attributed to increased sales volume (-0.7%) offset by miscellaneous increases in other selling and administrative expenses in excess of the percentage increase in net sales.
In connection with the preparation of the Company's audited financial statements for its fiscal year ending December 31, 2008, the Company completed its annual evaluation of goodwill in accordance with FAS No. 142. As a result, the Company recognized a goodwill impairment loss of $1,617,411 in the fourth quarter of 2008. The decline in fair value that resulted in the impairment was primarily attributed to the significant economic downturn currently being experienced in the United States. After recognition of this impairment loss, there is no goodwill remaining on the Company's consolidated balance sheet as of December 31, 2008.
Interest expense as a percentage of sales was 0.3% in 2008 and 2007.
The effective income tax rate in 2008 was 44.7% and in 2007 was 32.9%. The increase in 2008 is primarily due to the non-deductible portion of the goodwill impairment loss (6.1%) and the impact of the change in unrecognized tax benefits (6.8%). The 2007 tax provision included the results of an audit of our federal tax returns for 2004 and 2005 as well as the expiration of the statute of limitations on various other uncertain tax positions. There were no significant amounts of this nature included in the 2008 tax provision.
The Company reported losses from discontinued operations of 0.1% and 1.0% of sales for the years 2008 and 2007, respectively. As discussed above, during the fourth quarter of 2007, we made a decision to divest Sope Creek. At the beginning of February 2008, we sold the operations of Sope Creek. As a result, we classified the assets of Sope Creek as held for sale at December 31, 2007 and marked them down to their estimated fair value less selling costs. Additionally, we reclassified the results of operations of Sope Creek to loss from discontinued operations in the consolidated statements of earnings. We do not expect any further losses from the discontinued operations of Sope Creek.
LIQUIDITY AND CAPITAL RESOURCES: The Company uses a number of standards for its own purposes in measuring its liquidity, such as: working capital, profitability ratios, long-term debt as a percentage of long-term debt and equity, and activity ratios.
Accounts receivable decreased 6.5% from $18,670,466 on December 31, 2007 to $17,464,279 as of December 31, 2008. The decrease is primarily attributed to improvement in the aging of customer accounts as well as a decline in net sales during the fourth quarter of 2008.
Inventories decreased 6.6% from $46,463,662 on December 31, 2007 to $43,410,146 as of December 31, 2008. The decrease is primarily attributed to increases in inventory levels in 2007 in preparation for implementing several large new customer programs during the first part of 2008.
Prepaid expenses and other current assets decreased 26.5% from $3,525,114 on December 31, 2007 to $2,590,350 as of December 31, 2008. $505,000 of this decrease is attributed to a decrease in deposits for inventory paid for in advance of receipt and $280,000 is due to a decrease in refundable income taxes in the current year. The remainder of the fluctuation is attributed to a decrease in prepaid general expenses.
Other assets decreased 88.2% from $2,204,434 on December 31, 2007 to $260,039 as of December 31, 2008. This decrease is primarily attributed to the decrease in the amount of pension assets recognized in other assets of $1,937,000.
Accounts payable decreased 30.3% from $6,635,412 on December 31, 2007 to $4,626,789 on December 31, 2008 primarily due to lower inventory purchases in the current year.
Other current liabilities decreased 1.2% from $2,549,680 on December 31, 2007 to $2,518,956 on December 31, 2008.
Long-term pension liability increased 664.3% from $923,184 on December 31, 2007 to $7,056,055 on December 31, 2008 as a result of the significant decline in the fair value of the pension plan assets in the current year. The Company plans to contribute $1,000,000 to its defined benefit pension plans in 2009.
Cash flows related to discontinued operations are not segregated in the statements of cash flows. Cash flows from operating activities related to discontinued operations were insignificant in 2008 and were approximately $155,000 in 2007. Cash flows used in investing and financing activities for discontinued operations were insignificant in 2008 and 2007.
The working capital of the Company at December 31, 2008 was approximately $55,802,000 and the working capital ratio was 8.2:1. At December 31, 2007 the working capital of the Company was approximately $59,251,000 and the working capital ratio was 6.5:1. The Company has operated without hindrance or restraint with its present working capital, believing that income generated from operations and outside sources of credit, both trade and institutional, are more than adequate to fund the Company's operations.
In 2008, the Company's percentage of total debt to total debt and equity was 6.2%. In 2007 the Company's percentage of total debt to total debt and equity was 5.2%.
The Company has an on-going capital expenditure program designed to maintain and improve its facilities. Capital expenditures were approximately $2,271,000 and $1,163,000, in the years 2008 and 2007, respectively.
During the years ended December 31, 2008 and 2007, the Company paid cash dividends of approximately $3,494,000 and $3,591,000, respectively, resulting from a quarterly dividend of $.135 per share. In May 2006, the Board of Directors reset the common stock repurchase program authorization so that the Company could make future repurchases of up to 750,000 of its common shares. Through July 31, 2008, the Company repurchased 625,881 shares of its common stock under such repurchase program. On August 1, 2008, the Company's Board of Directors reset the common stock repurchase program authorization to allow for the repurchase of 1,000,000 additional shares of the Company's outstanding shares of common stock. The Company reacquired and retired 617,096 shares and 0 shares of its common stock in the years ended December 31, 2008 and 2007, respectively, with approximate costs of $5,712,000, and $0, respectively. At December 31, 2008, the Company had 588,615 shares remaining on its common stock repurchase authorization. Shares purchased under our share repurchase program are constructively retired and returned to unissued status. We consider several factors in determining when to make share repurchases, including among other things, our cost of equity, our after-tax cost of borrowing, our debt to total capitalization targets and our expected future cash needs. There is no expiration date or other restriction governing the period over which we can make our share repurchases under the program. The Company anticipates that it will continue to pay dividends and that it will repurchase additional shares of its common stock in the future as financial conditions permit.
In 2008, cash and cash equivalents decreased by approximately $637,000. This decrease is attributed to approximately $10,426,000 in cash provided from operations, offset by approximately $1,919,000 utilized in investing activities, as well as approximately $9,144,000 utilized in financing activities. Investing activities consisted primarily of capital expenditures, including approximately $1,268,000 spent to purchase an office building in El Salvador. Financing activities consisted primarily of dividends paid and the repurchase of approximately $5,712,000 of Company stock, as discussed above, which were offset by debt proceeds of approximately $33,000.
In 2007, cash and cash equivalents decreased by approximately $3,151,000. This decrease was attributed to approximately $839,000 in cash provided from operations, offset by approximately $1,004,000 utilized in investing activities, as well as approximately $2,986,000 utilized in financing activities. Investing activities consisted primarily of capital expenditures. Financing activities consisted primarily of dividends paid, as discussed above, which were offset by debt proceeds of approximately $17,000 and approximately $562,000 in proceeds from the exercise of employee stock options.
On March 26, 1999, the Company entered into a 3-year credit agreement with Wachovia Bank that made available to the Company up to $15,000,000 on a revolving credit basis. Interest is payable at LIBOR plus 0.60% based upon the one-month LIBOR rate for U.S. dollar based borrowings (4.4% at December 31, 2008). The Company pays an annual commitment fee of 0.15% on the average unused portion of the commitment. The available balance under the credit agreement is reduced by outstanding letters of credit. As of December 31, 2008, $3,379,000 was outstanding on the revolver and approximately $85,000 was outstanding under letters of credit. On March 27, 2001, on April 27, 2004, and again on June 25, 2007, the Company entered into agreements with Wachovia Bank to extend the maturity of the revolving credit agreement. The revolving credit agreement matures on June 30, 2010. At the option of the Company, any outstanding balance on the agreement at that date will convert to a one-year term loan. The remaining terms of the original revolving credit agreement remain unchanged. The Company also entered into a $12,000,000 10-year term loan on March 26, 1999 with the same bank. The term loan is an amortizing loan, with monthly payments of principal and interest, maturing on April 1, 2009. The term loan carries a variable interest rate of LIBOR plus 0.80% based upon the one-month LIBOR rate for U.S. dollar based borrowings. Concurrent with the execution of the term loan agreement, the Company entered into an interest rate swap with the bank under which the Company receives a variable rate of interest on a notional amount equal to the outstanding balance of the term loan from the bank and the Company pays a fixed rate of 6.75% on a notional amount equal to the outstanding balance of the term loan to the bank.
The credit agreement and the term loan with Wachovia contain restrictive provisions concerning liabilities to tangible net worth ratio (.75:1), other borrowings, capital expenditures, working capital ratio (2.5:1), and fixed charges coverage ratio (2.5:1). The Company is in full compliance with all terms, conditions and covenants of the various credit agreements.
With funds from the credit agreement, anticipated cash flows generated from operations and other credit sources readily available, the Company believes that its liquidity is satisfactory, its working capital adequate and its capital resources sufficient for funding its ongoing capital expenditure program and its operations, including planned expansion for 2009.
OFF-BALANCE SHEET ARRANGEMENTS:
The Company does not engage in any off-balance sheet financing arrangements. In particular, we do not have any interest in variable interest entities, which include special purpose entities and structured finance entities.
CRITICAL ACCOUNTING POLICIES:
Our significant accounting policies are described in Note 1 to the consolidated financial statements included in this Annual Report on Form 10-K. Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the estimates that we have made. These estimates are based upon our historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Our actual results may differ from these estimates under different assumptions or conditions.
Our critical accounting estimates are those that we believe require our most significant judgments about the effect of matters that are inherently uncertain. A discussion of our critical accounting estimates, the underlying judgments and uncertainties used to make them and the likelihood that materially different estimates would be reported under different conditions or using different assumptions is as follows:
Allowance for Losses on Accounts Receivable
These allowances are based on both recent trends of certain customers estimated to be a greater credit risk as well as general trends of the entire customer pool. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. An additional impairment in value of one percent of net accounts receivable would require an increase in the allowance for doubtful accounts and would result in additional expense of approximately $175,000. The Company's concentration of risk is also monitored and at year-end 2008, the largest outstanding customer account balance was $2,357,000 and the five largest account balances totaled $5,857,000.
Inventories
Inventories are stated at the lower of cost or market value. Judgments and estimates are used in determining the likelihood that new goods on hand can be sold to customers. Historical inventory usage and current revenue trends are considered in estimating both excess and obsolete inventories. If actual product demand and market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Goodwill Impairment
The Company had $1,617,000 of goodwill on its consolidated balance sheet at December 31, 2008, prior to the completion of our year-end impairment testing. The review of fair value involves judgment and estimates of discount rates, transaction multiples and future cash flows for the reporting unit that may be impacted by future sales and operating results for the reporting unit, market conditions and economic conditions. The Company analyzed various discount rates, transaction multiples and cash flows for the reporting unit. As a result of these calculations, we determined that the remaining goodwill was fully impaired and the Company took a charge as a goodwill impairment loss in the amount of $1,617,000. There is no goodwill remaining on the consolidated balance sheet at December 31, 2008.
Insurance
The Company self-insures for certain obligations related to health insurance programs. The Company also purchases stop-loss insurance policies to protect it from catastrophic losses. Judgments and estimates are used in determining the potential value associated with reported claims and for losses that have occurred, but have not been reported. The Company's estimates consider historical claim experience and other factors. The Company's liabilities are based on estimates, and, while the Company believes that the accrual for loss is adequate, the ultimate liability may be in excess of or less than the amounts recorded. Changes in claim experience, the Company's ability to settle claims or other estimates and judgments used by management could have a material impact on the amount and timing of expense for any period.
Pensions
The Company's pension obligations are determined using estimates including those related to discount rates, asset values and changes in compensation. The discount rates used for the Company's pension plans of 5.99% to 6.13%, were determined based on the Citigroup Pension Yield Curve. This rate was selected as the best estimate of the rate at which the benefit obligations could be effectively settled on the measurement date taking into account the nature and duration of the benefit obligations of the plan using high-quality fixed-income investments currently available (rated AA or better) and expected to be available during the period to maturity of the benefits. The 8% expected return on plan assets was determined based on historical long-term investment returns as well as future expectations given target investment asset allocations and current economic conditions. The 4.5% rate of compensation increase represents the long-term assumption for expected increases in salaries among continuing active participants accruing benefits under the plans. In 2008, a reduction in the expected return on plan assets of 0.25% would have resulted in additional expense of approximately $45,000, while a reduction in the discount rate of 0.25% would have resulted in additional expense of approximately $90,000 and would have reduced the funded status by $730,000 for the Company's defined benefit pension plans. Interest rates and pension plan valuations may vary significantly based on worldwide economic conditions and asset investment decisions.
Income Taxes
The Company is required to estimate and record income taxes payable for federal and state jurisdictions in which the Company operates. This process involves estimating actual current tax expense and assessing temporary differences resulting from differing accounting treatment between tax and book that result in deferred tax assets and liabilities. In addition, accruals are also estimated for federal and state tax matters for which deductibility is subject to interpretation. Taxes payable and the related deferred tax differences may be impacted by changes to tax laws, changes in tax rates and changes in taxable profits and losses. Reserves are also estimated for uncertain tax positions
that are currently unresolved. The Company routinely monitors the potential impact of such situations and believes that it is properly reserved. For the year ending December 31, 2008, we recognized a net increase in total unrecognized tax benefits of approximately $62,000, primarily as a result of tax positions related to 2008. As of December 31, 2008, we had an accrued liability of $665,000 for unrecognized tax benefits. We accrue interest and penalties related to unrecognized tax benefits in income tax expense, and the related liability is included in the total liability for unrecognized tax benefits under FIN 48.
Share-based Compensation
We adopted Statement of Financial Accounting Standards No. 123 (revised 2004) ("FAS No. 123R") on January 1, 2006. FAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. This statement revises FAS 123, and supersedes Accounting Principles Board (APB) Opinion 25. Share-based compensation expense that was recorded in 2008 and 2007 includes the compensation expense for the share-based payments granted in those years. In our share-based compensation strategy we utilize a combination of stock options and stock appreciation rights ("SARS") that fully vest on the date of grant. Therefore, the fair value of the options and SARS granted is recognized as expense on the date of grant. We used the Black-Scholes-Merton valuation model to value any share-based compensation under FAS 123R. Option valuation methods, including Black-Scholes-Merton, require the input of assumptions including the risk free interest rate, dividend rate, expected term and volatility rate. The Company determines the assumptions to be used based upon current economic conditions. The impact of changing any of the individual assumptions by 10% would not have a material impact on the recorded expense.
Recent Accounting Pronouncements
In September 2006, the FASB issued FAS No. 157, Fair Value Measurements ("FAS No. 157"). FAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. We have adopted FASB Staff Position 157-2, Effective Date of FASB Statement No. 157 ("FSP No. 157-2"), issued February 2008, and as a result we applied the provisions of FAS No. 157 that are applicable as of January 1, 2008, which had no material effect on our consolidated financial statements. FSP No. 157-2 delays the effective date of SFAS 157 for certain non-financial assets and non-financial liabilities until January 1, 2009.
In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities ("FAS No. 159") which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. FAS No. 159 was effective for the Company on January 1, 2008. The adoption of FAS No. 159 has not had a material effect on our consolidated financial statements.
In December 2007, the FASB issued FAS No. 141 (revised 2007) (FAS No. 141(R)), Business Combinations, which is a revision of FAS No. 141, Business Combinations. The primary requirements of FAS No. 141(R) are as follows: (I.) Upon initially obtaining control, the acquiring entity in a business combination must recognize 100% of the fair values of the acquired assets, including goodwill, and assumed liabilities, with only limited exceptions even if the acquirer has not acquired 100% of its target. As a consequence, the current step acquisition model will be eliminated. (II.) Contingent consideration arrangements will be fair valued at the acquisition date and included on that basis in the purchase price consideration. The concept of recognizing contingent consideration at a later date when the amount of that consideration is determinable beyond a reasonable doubt, will no longer be applicable. (III.) All transaction costs will be expensed as incurred. FAS No. 141 (R) is effective as of the beginning of an entity's first fiscal year beginning after December 15, 2008. Adoption is prospective and early adoption is not permitted. The Company does not believe the adoption of this standard will have an impact on its consolidated financial statements.
A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to the Company's consolidated financial statements.
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