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SGC > SEC Filings for SGC > Form 10-K on 14-Mar-2013All Recent SEC Filings

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Form 10-K for SUPERIOR UNIFORM GROUP INC


14-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations

Business Outlook

The current economic environment in the United States remains very challenging. Our primary products are provided to workers employed by our customers and, as a result, our business prospects are dependent upon levels of employment among other factors. Our revenues are impacted by our customers' opening and closing of locations and reductions and increases in headcount. Additionally, voluntary employee turnover has been reduced significantly as a result of fewer alternative jobs available to employees of our customers. Fewer available jobs coupled with less attrition results in decreased demand for our uniforms and service apparel.

Our focus is geared towards mitigating these factors in the current economic environment and has included the following strategies. First, we are actively pursuing acquisitions to increase our market share in the Uniforms and Related Products segment and it is our intention to continue to seek additional acquisitions that fit into this segment in the future. Second, we diversified our business model to include the Remote Staffing Solutions segment. This business segment was started to provide these services for the Company at a lower cost structure in order to improve our own operating results. This segment, located in El Salvador, Belize, and the United States, has enabled us to reduce our operating expenses and to more effectively service our customers' needs. We added our Belize location at the end of 2012 and eliminated our Costa Rica location at the same time. The Belize operation offers a more competitive cost structure for the Company as compared to Costa Rica. We began selling these services to other companies at the end of 2009. We have grown this business from approximately $1 million in net sales to outside customers in 2010 to approximately $3.5 million in net sales to outside customers in 2012. We spent significant effort in 2012 improving our management infrastructure in this segment to support significant growth in this segment in 2013 and beyond. While net sales to outside customers for this segment increased 17.9% during the full year 2012, fourth quarter net sales to outside customers in this segment increased by 55%. We are aggressively marketing this service and we believe this sector will grow significantly in 2013 and beyond. Finally, we are pursuing new product lines to enhance our market position in the Uniforms and Related Products segment. Toward this end, we entered into a licensing agreement in January of 2011. This licensing agreement provides us with access to patented technology which will allow us to market image apparel to our customers that will provide them with the ability to turn their uniforms from an expense item into point of sale advertisements that will, in turn, give them the ability to generate advertising revenues for their businesses.

Although we believe that this new product line provides us with an opportunity for significant growth in our Uniforms and Related Products segment in the future, we have not been able to generate any significant revenues from the product line during the last two years. We have attempted to negotiate an extension of the initial term of the licensing agreement and are continuing to pursue this extension. However, we have not been successful to this point and cannot be assured that we will ultimately be able to negotiate an extension on reasonable terms. Additionally, we have been involved in two significant test programs with two separate customers during 2012. One of these programs was with a major retailer in the northeast in the fourth quarter. The test was adversely affected by hurricane Sandy and as a result, the customer determined that it did not have sufficient data to conclude on moving forward with a full program. We are in the process of developing another test program with this customer in 2013. Additionally, while the feedback from the other test program has been positive, the customer has been slow to move to a full revenue producing program at this point. As a result of these items and the lack of an extension of the initial term at this point, we concluded that we did not have adequate, verifiable cash flows to support recovery of the intangible asset on our statement of financial position at December 31, 2012. Therefore, we recorded a pre-tax, non-cash impairment charge of $1,226,000 in the fourth quarter of 2012 to write off the remaining balance of the licensing agreement.

During the latter part of 2010, cotton prices began increasing dramatically and reached historical highs during 2011 due to weather-related and other supply disruptions, which when combined with robust global demand, particularly in Asia, created concerns about availability in addition to increased costs for our products. While we were able to pass on a portion of these price increases to our customers during most of 2011, we began to see a negative impact on our gross margins in the fourth quarter of 2011. This trend continued for us through the end of the third quarter of 2012 at which point we began to realize cost reductions as cotton prices began to stabilize. Our fourth quarter margins began to show improvement in comparison to the first three quarters of 2012. We expect to see continued improvement in our gross margins in our Uniforms and Related Products segment in 2013.


Operations

Net Sales

                                    2012              2011          % Change
Uniforms and Related Products   $ 116,029,000     $ 109,442,000           6.0 %
Remote Staffing Solutions           7,196,000         6,610,000           8.9 %
Net intersegment eliminations      (3,739,000 )      (3,679,000 )         1.6 %
Consolidated Net Sales          $ 119,486,000     $ 112,373,000           6.3 %

Net sales increased 6.3% from $112,373,000 in 2011 to $119,486,000 in 2012. The increase in net sales is split between growth in our Uniforms and Related Products segment (5.8%) and increases in net sales after intersegment eliminations from our Remote Staffing Solutions segment (0.5%). Intersegment eliminations reduce total net sales for sales of Remote Staffing Solutions to the Uniforms and Related Products segment by the Remote Staffing Solutions segment.

Uniforms and Related Products net sales increased 6.0% in 2012. This increase is attributed to increased market penetration offset by continued softness in markets as the economic environment has remained challenging in 2012.

Remote Staffing Solutions net sales increased 8.9% before intersegment eliminations and 17.9% after intersegment eliminations in 2012. This growth is attributed to additional market penetration in 2012.

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products Segment was 67.4% in 2012, and 64.7% in 2011. The percentage increase in 2012 as compared to 2011 is primarily attributed to an increase in direct product costs as a percentage of net sales during the current year (3.1%) due to higher raw material costs primarily related to shortages of cotton. This increase was offset by a reduction in overhead costs as a percentage of sales as a result of higher volume in the current period (0.4%).

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions Segment was 40.9% in 2012, and 38.5% in 2011. The percentage increase in 2012 compared to 2011 is attributed primarily to increases in payroll related costs as a percentage of net sales for services provided to the Uniforms and Related Products segment (2.5%) as a result of higher payroll related costs for these services without a corresponding increase in rates charged to the Uniforms and Related Products Segment.

As a percentage of net sales, selling and administrative expenses for our Uniforms and Related Products Segment approximated 29.2% in 2012 and 31.9% in 2011. The decrease as a percentage of sales is attributed primarily to the impact of higher net sales to cover operating expenses (1.8%), lower incentive compensation expense as a result of lower earnings (1.0%), a major consulting project completed in the second quarter of 2011 to study customer markets and refine our strategic plan to capitalize on the opportunities identified (0.5%) and reduced depreciation expense (0.6%) offset by increased costs associated with the Company's pension plans (0.4%) and minor increases in various other costs (0.8%).

As a result of the items discussed in the Business Outlook section above, we concluded that we did not have adequate, verifiable cash flows to support recovery of the intangible asset associated with our licensing agreement at December 31, 2012. Therefore, we recognized a pre-tax, non-cash impairment charge of $1,226,000 in the fourth quarter of 2012 to write off the remaining balance of the licensing agreement. This impairment charge is included in the results of our Uniforms and Related Products segment.

As a percentage of net sales, selling and administrative expenses for our Remote Staffing Solutions Segment approximated 32.9% in 2012 and 33.6% in 2011. The decrease as a percentage of sales is attributed primarily to the impact of higher net sales to cover operating expenses (2.9%), reduced bad debt expense in 2012 (2.3%), offset by an increase in salaries, wages and benefits (1.4%) as the Company staffed up to support future growth of this segment and increased outside broker fees as the Company supplemented its internal sales efforts with independent brokers in 2012 (2.9%) and other miscellaneous increases (0.2%).

The effective income tax rate in 2012 was 34.4% and in 2011 was 26.0%. The 8.4% increase in the effective tax rate is attributed primarily to the following: a decrease in the benefit for untaxed foreign income (1.3%), an increase in foreign income tax expense (1.5%), an increase in the state income tax rate (1.0%), an increase in the accrual for uncertain tax positions (0.2%), an increase due to a non-deductible portion of intangible asset impairment (1.8%), an increase from the impact of permanent differences between book and tax basis earnings related to share-based compensation (1.0%), and an increase in the impact of other items (1.6%). During the years ended December 31, 2012 and 2011, the Company did not recognize deferred income taxes on foreign income of $1,437,000 and $1,952,000, respectively, due to the fact that these amounts are considered to be reinvested indefinitely in foreign subsidiaries. Based upon our current expectations, we do not expect to recognize deferred income taxes on our 2013 foreign income as this income is expected to be reinvested indefinitely in foreign subsidiaries.


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. The Company's balance sheet is very strong at this point and provides the ability to pursue acquisitions, to invest in new product lines and technologies, and to invest in additional working capital as necessary. We have a $15 million revolving credit facility available for use in the event we should need it, under which no debt is outstanding at December 31, 2012. As of December 31, 2012, approximately $2,710,000 of our cash is held in our foreign subsidiaries and cannot be repatriated without recognizing and paying Federal income taxes on this amount.

Accounts receivable increased 4.5% from $15,942,000 on December 31, 2011 to $16,655,000 as of December 31, 2012. The increase is primarily attributed to higher sales in the current period.

Accounts receivable - other decreased 20% from $3,745,000 on December 31, 2011 to $2,995,000 as of December 31, 2012 as a result of lower receivables from our suppliers related to fabric inventories held at their locations. As the severe cotton shortages in 2011 have subsided, we have reduced the amount of fabric required to be held at these suppliers.

Inventories decreased 4.8% from $41,208,000 on December 31, 2011 to $39,246,000 as of December 31, 2012. As previously discussed, the Company increased raw material inventories during 2011 in order to protect its customers from potential shortages of cotton fabrics. We believe we reached sufficient levels to achieve this objective for our inventories and have been able to reduce the levels accordingly in 2012.

Other intangible assets decreased 79.7% from $2,749,000 to $559,000. This decrease is due to normal amortization expense of $964,000 and an impairment charge of $1,226,000 to write off the remaining balance of the licensing agreement discussed above. The normal amortization above included $818,000 of amortization associated with the licensing agreement and as such, the 2013 amortization expense for the remaining intangible asset will be significantly lower.

Accounts payable increased 11.6% from $5,941,000 on December 31, 2011 to $6,629,000 on December 31, 2012. This increase is primarily due to the timing of purchases of inventory at year-end 2012 compared to 2011.

Other current liabilities decreased 28.4% from $4,499,000 on December 31, 2011 to $3,222,000 on December 31, 2012, due primarily to reduced accruals for incentive compensation as a result of lower earnings in 2012.

Long-term pension liability increased 29.5% from $8,086,000 on December 31, 2011 to $10,468,000 on December 31, 2012. The increase in this liability is primarily attributed to actuarial losses in the current period of approximately $3,469,000 and current year interest cost of $1,023,000 offset by current year returns on assets of $2,155,000.

At December 31, 2012, the working capital of the Company was approximately $55,393,000 and the working capital ratio was 6.6:1. At December 31, 2011, the working capital of the Company was approximately $55,784,000 and the working capital ratio was 6.3:1. 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.

The Company has an on-going capital expenditure program designed to maintain and improve its facilities. Capital expenditures were approximately $1,647,000 and $913,000 in 2012 and 2011, respectively.

During the years ended December 31, 2012 and 2011, the Company paid cash dividends of approximately $6,574,000 and $3,235,000, respectively, resulting from quarterly dividends of $0.135 per share and a special dividend of $0.54 in 2012. On December 31, 2012, the Company paid the special dividend of $0.54 per share representing a prepayment - and payment in lieu of - the Company's anticipated regular quarterly dividend for 2013 in order to take advantage of a tax efficient method to return capital to our shareholders prior to anticipated increases in tax rates associated with dividends.


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 36,570 shares and 76,693 shares of its common stock in the years ended December 31, 2012 and 2011, respectively, with approximate costs of $437,000 and $882,000, respectively. At December 31, 2012, the Company had 274,886 shares remaining for purchase under its common stock repurchase authorization. Shares purchased under the 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 2012, cash and cash equivalents increased by approximately $750,000. $9,158,000 in cash was provided by operating activities, $1,646,000 was used in investing activities consisting of net capital expenditures, and $6,762,000 was used in financing activities. Financing activities included the payment of cash dividends, as discussed above, $640,000 of debt reduction and common stock reacquired and retired of $437,000 offset by net proceeds from exercises of stock options of $889,000.

On June 25, 2010, the Company entered into a three-year credit agreement with Fifth Third Bank that made available to the Company up to $15,000,000 on a revolving credit basis. Interest is payable at LIBOR (rounded up to the next 1/8th of 1%) plus 0.90% based upon the one-month LIBOR rate for U.S.-dollar based borrowings (1.15% at December 31, 2012). 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, 2012, there were no balances outstanding under letters of credit. The revolving credit agreement expires on June 24, 2013. At the option of the Company, any outstanding balance on the agreement at that date will convert to a one-year term loan. We anticipate we will be able to renew or replace the agreement before its expiration.

The credit agreement with Fifth Third Bank contains restrictive provisions concerning liabilities to tangible net worth ratios (.75:1), other borrowings, and a fixed charges coverage ratio (2.5:1). The Company is in full compliance with all terms, conditions and covenants of the credit agreement.

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 2013.

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 $167,000. The Company's concentration of risk is also monitored and at year-end 2012, no customer had an account balance greater than 10% of receivables and the five largest customer account balances totaled $4,930,000. Additionally, the Company advances funds for certain of its suppliers to purchase raw materials. The Company deducts payment for these raw materials from payments made to the suppliers upon completion of the related finished goods. The Company had a receivables balance from one of its suppliers located in Haiti totaling approximately $2,966,000 at December 31, 2012. This amount is included in accounts receivable-other on the consolidated balance sheet.


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.

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 3.77% to 3.93% 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 3.0% rate of compensation increase represents the long-term assumption for expected increases in salaries among continuing active participants accruing benefits under the plans. In 2012, a reduction in the expected return on plan assets of 0.25% would have resulted in additional expense of approximately $42,000, while a reduction in the discount rate of 0.25% would have resulted in additional expense of approximately $139,000 and would have reduced the funded status by $1,190,000 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, state and foreign 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. Federal income taxes are not provided on that portion of unremitted earnings of foreign subsidiaries that are expected to be reinvested indefinitely. 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, 2012, we recognized a net increase in total unrecognized tax benefits of approximately $1,000. As of December 31, 2012, we had an accrued liability of $736,000 for unrecognized tax benefits. We accrue interest and penalties related to unrecognized tax benefits in income tax expense, and the related liability is included inother long-term liabilities on the accompanying consolidated balance sheet.

Share-Based Compensation
The Company recognizes expense for all share-based payments to employees, including grants of employee stock options, in the financial statements based on their fair values. Share-based compensation expense that was recorded in 2012 and 2011 includes the compensation expense for the share-based payments granted in those years. In the Company's 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. The Company used the Black-Scholes-Merton valuation model to value any share-based compensation. 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.


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