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SGC > SEC Filings for SGC > Form 10-Q on 19-Apr-2013All Recent SEC Filings

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Form 10-Q for SUPERIOR UNIFORM GROUP INC


19-Apr-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Certain matters discussed in this Form 10-Q are "forward-looking statements" intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as we "believe," "anticipate," "expect" or words of similar import. Similarly, statements that describe our future plans, objectives, strategies or goals are also forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation: (1) projections of revenue, income, and other financial items, (2) statements of our plans, objectives, and intentions, (3) statements regarding the capabilities, capacities, and expected development of our business operations, and (4) statements of expected future economic performance. Such forward-looking statements are subject to certain risks and uncertainties that may materially adversely affect the anticipated results. Such risks and uncertainties include, but are not limited to, the following: general economic conditions, including employment levels, in the areas of the United States in which the Company's customers are located; changes in the healthcare, resort and commercial industries where uniforms and service apparel are worn; the impact of competition; the price and availability of cotton and other manufacturing materials, and other factors described in the Company's filings with the Securities and Exchange Commission, including those described in the "Risk Factors" section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements made herein and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Form 10-Q and we disclaim any obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

Critical Accounting Policies
Our significant accounting policies are described in Note 1 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. 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 $173,000.

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.

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 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. 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 treatments 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 income 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. 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.

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 2013 and 2012 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-settled stock appreciation rights ("SARS") that fully vest on the date of grant. Therefore, the fair value of the options and stock-settled 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.

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. Our net sales to outside customers in this segment increased by 84% in the first quarter of 2013 as compared to the same quarter in 2012. We are aggressively marketing this service and we believe this sector will continue to 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 growth in our Uniforms and Related Products segment in the future, we have yet to generate any significant revenues from this product line. 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.

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 and this trend continued to improve significantly in the first quarter of 2013. We expect to see continued improvement in our gross margins in our Uniforms and Related Products segment in the balance of 2013 in comparison to the same amounts in the comparable periods of 2012.

Results of Operations

Net sales increased 8.7% from $28,508,000 for the three months ended March 31, 2012 to $30,985,000 for the three months ended March 31, 2013. The 8.7% increase in net sales for the quarter is split between growth in our Uniforms and Related Products segment (6.7%) and increases in net sales after intersegment eliminations from our Remote Staffing Solutions Segment (2.0%). 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. See Note 7 to Consolidated Financial Statements for more information and a reconciliation of segment net sales to total net sales.

Uniforms and Related Products net sales increased 6.8% for the three months ended March 31, 2013. This increase is attributed to increased market penetration offset by continued softness in markets as the economic environment remains challenging in 2013.

Remote Staffing Solutions net sales increased 33.0% before intersegment eliminations and 84.2% after intersegment eliminations for the three months ended March 31, 2013. This increase is attributed to continued market penetration in 2013.

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products Segment was 64.5% for the three months ended March 31, 2013 and 67.2% in the comparable period for 2012. The percentage decrease in 2013 as a percentage of net sales is primarily attributed to a decrease in direct product costs as a percentage of net sales during the current year (2.0%) due to lower raw material costs primarily related to the impact of shortages of cotton on the 2012 costs. Additionally, there was a reduction in overhead costs as a percentage of net sales as a result of higher volume in the current period (0.7%).

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions Segment was 37.2% for the three months ended March 31, 2013, and 41.1% in the comparable period for 2012. The percentage decrease in 2013 as compared to 2012 is primarily attributed to the addition of higher gross margin accounts that were added in the current period.

As a percentage of net sales, selling and administrative expenses for our Uniforms and Related Products Segment was 31.4% for the three months ended March 31, 2013 and 32.3% in the comparable period for 2012. The decrease as a percentage of sales is attributed primarily to the impact of higher net sales to cover operating expenses (2.1%), lower amortization of intangibles as a result of the write off of the remaining licensing agreement balance in the fourth quarter of 2012 (0.7%), partially offset by higher incentive compensation expense as a result of higher earnings (1.1%), and minor increases in various other costs (0.8%).

As a percentage of net sales, selling and administrative expenses for our Remote Staffing Solutions Segment was 37.8% for the three months ended March 31, 2013 and 34.2% in the comparable period for 2012. The increase as a percentage of sales is attributed primarily to an increase in salaries, wages and benefits (2.8%) as the Company staffed up to support significant future growth of this segment and increased outside broker fees as the Company supplemented its internal sales efforts with independent brokers in 2013 (3.2%) and other miscellaneous decreases including higher net sales to cover fixed operating expenses (2.4%).

The Company's effective tax rate for the three months ended March 31, 2013 was 29.7% versus 39.1% for the three months ended March 31, 2012. The 9.4% decrease in the effective tax rate is attributed primarily to an increase in the benefit for untaxed foreign income (4.8%), reduced provisions for uncertain tax positions (3.7%), a reduction in our non-deductible qualified stock compensation expense (0.6%) and other items (0.3%).


Liquidity and Capital Resources

Accounts receivable - trade increased 4.0% from $16,655,000 on December 31, 2012 to $17,318,000 on March 31, 2013 primarily due to higher net sales in the month of March 2013 in comparison to December of 2012.

Inventories increased 0.2% from $39,246,000 on December 31, 2012 to $39,340,000 as of March 31, 2013 in order to support increased net sales in the current period.

Other intangible assets decreased 6.4% from $559,000 on December 31, 2012 to $523,000 on March 31, 2013. This decrease is attributed to normal amortization of existing intangible assets.

Accounts payable decreased 5.8% from $6,629,000 on December 31, 2012 to $6,246,000 on March 31, 2013. This decrease is primarily attributed to timing of inventory purchases in the current period.

Other current liabilities decreased 11.8% from $3,222,000 on December 31, 2012 to $2,843,000 on March 31, 2013. This decrease is primarily due to the payment of year-end incentive compensation during the first quarter of 2013 offset by the accrual of current year incentive compensation in the first quarter of 2013.

Cash and cash equivalents decreased by $61,000 from $3,554,000 on December 31, 2012 to $3,493,000 as of March 31, 2013. During 2013, the Company generated $308,000 in cash from operating activities, used $552,000 in investing activities consisting of fixed asset additions, and generated $183,000 from financing activities. Financing activities consisted of proceeds received from the exercise of stock options of $63,000 and net borrowings under the Company's revolving line of credit of $120,000.

In the foreseeable future, the Company will continue its ongoing capital expenditure program designed to maintain and improve its facilities. The Company at all times evaluates its capital expenditure program in light of prevailing economic conditions.

During the three months ended March 31, 2013 and 2012, respectively, the Company paid cash dividends of $-0- and $812,000. The Company reacquired -0- and 3,298 shares of its common stock at a total cost of $-0- and $41,000 in the three-month periods ended March 31, 2013 and 2012, respectively, pursuant to its share repurchase program. On December 31, 2012, the Company paid a 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. The Company anticipates that it will resume paying dividends beginning in 2014 and that it will reacquire and retire additional shares of its common stock in the future as financial conditions permit.

On June 25, 2010, the Company entered into a 3-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 plus 0.90% (rounded up to the next 1/8th of 1%) based upon the one-month LIBOR rate for U.S. dollar based borrowings (1.15% at March 31, 2013). 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 March 31, 2013, there were no balances outstanding under letters of credit. As of March 31, 2013, there was an outstanding balance of $120,000 under this credit agreement. 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 fixed charges coverage ratio (2.5:1). The Company is in full compliance with all terms, conditions and covenants of the credit agreement.

The Company believes that its cash flows from operating activities together with other capital resources and funds from credit sources will be adequate to meet all of its funding requirements for the remainder of the year and for the foreseeable future.

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