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SWSH > SEC Filings for SWSH > Form 10-K on 1-May-2013All Recent SEC Filings

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Form 10-K for SWISHER HYGIENE INC.


1-May-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion and analysis in conjunction with the "Selected Financial Data" included in Item 6 and our audited Consolidated Financial Statements and the related notes thereto included in Item 8 "Financial Statements and Supplementary Data." In addition to historical consolidated financial information, this discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Actual results could differ from these expectations as a result of factors including those described under Item 1A, "Risk Factors," "Forward-Looking Statements" and elsewhere in this annual report.

Business Overview and Outlook

Swisher Hygiene Inc. provides essential hygiene and sanitizing solutions to customers throughout much of North America and internationally through its network of company owned operations, franchisees and master licensees. These solutions include essential products and services that are designed to promote superior cleanliness and sanitation in commercial environments, while enhancing the safety, satisfaction and well-being of employees and patrons. These solutions are typically delivered by employees on a regularly scheduled basis and involve providing our customers with: (i) consumable products such as detergent, cleaning chemicals, soap, paper and supplies, together with the rental and servicing of dish machines and other equipment for the dispensing of those products; (ii) the rental of facility service items requiring regular maintenance and cleaning, such as floor mats, mops, bar towels, and linens; and
(iii) manual cleaning of their facilities. We serve customers in a wide range of end-markets, with a particular emphasis on the foodservice, hospitality, retail, and healthcare industries.


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We believe the markets for our service and product offerings are highly fragmented with a small number of large national competitors and many small, private, local and regional businesses in each of our core marketplaces. These smaller independent market participants generally are not able to benefit from economies of scale in purchasing, manufacturing of chemical products, offering a full range of products or services, or providing the necessary level of support and customer service required by larger regional and national accounts within their specific markets. To address this opportunity, during 2010 and 2011, we implemented an acquisition growth strategy and acquired 72 franchises and independent businesses in the chemical manufacturing, hygiene and waste and recycling services businesses. These acquisitions supported our overall strategy to continue growing from our legacy business of restroom hygiene to the premier "one-stop-shop" for complete hygiene and sanitation solutions for our customers and resulted in the following: 1) the purchase of primarily all of our franchises, 2) the development of a national platform to provide chemical and related services to customers in our key end-markets, 3) the vertical integration of our business through the purchase of seven chemical manufacturing plants located around the country and 4) the entrance into the solid waste collection and recycling business.

During 2012 and continuing into 2013, we have continued to focus on leveraging the integration of our acquisitions and simplifying our operations. These initiatives include the consolidation of routes and branch locations, centralizing administrative functions and standardizing our operating model. Additionally, we are consolidating certain of our chemical manufacturing facilities and rationalizing our supply chain to reduce our manufacturing costs, provide our products to customers in the most efficient manner and consolidate our inventory.

During 2013, we intend to grow in our existing markets primarily through organic growth. We will continue to focus our investments towards those opportunities which will most benefit our core chemical businesses.

Audit Committee Review and Restatement

On March 21, 2012, Swisher's Board of Directors (the "Board") determined that the Company's previously issued interim financial statements for the quarterly periods ended June 30, 2011 and September 30, 2011, and the other financial information in the Company's quarterly reports on Form 10-Q for the periods then ended should no longer be relied upon. Subsequently, on March 27, 2012, the Audit Committee concluded that the Company's previously issued interim financial statements for the quarterly period ended March 31, 2011 should no longer be relied upon. The Board and Audit Committee made these determinations in connection with the Audit Committee's then ongoing review into certain accounting matters. We refer to the interim financial statements and the other financial information described above as the "Prior Financial Information."

The Audit Committee initiated its review after an informal inquiry by the Company and its independent auditor regarding a former employee's concerns with the application of certain accounting policies. The Company first initiated the informal inquiry by requesting that both the Audit Committee and the Company's independent auditor look into the matters raised by the former employee. Following this informal inquiry, the Company's senior management and its independent auditor advised the Chairman of the Company's Audit Committee regarding the matters. Subsequently, the Audit Committee determined that an independent review of the matters presented by the former employee should be conducted. During the course of its independent review, and due in part to the significant number of acquisitions made by the Company, the Audit Committee determined that it would be in the best interest of the Company and its stockholders to review the accounting entries relating to each of the 63 acquisitions made by the Company during the year ended December 31, 2011.

On May 17, 2012, the Company announced that the Audit Committee had substantially completed the investigative portion of its internal review. In connection with the substantial completion of its internal review, the Audit Committee recommended to the Board that the Company's Chief Financial Officer and two additional senior accounting personnel be separated from the Company as a result of their conduct in connection with the preparation of the Prior Financial Information. Following this recommendation, the Board determined that these three accounting personnel be separated from the Company, effective immediately. In making these employment determinations, the Board did not identify any conduct by these employees intended for or resulting in any personal benefit.

On February 19, 20, and 21, 2013, the Company filed amended quarterly reports on Form 10-Q/A for the quarterly periods ended March 31, 2011, June 30, 2011, and September 30, 2011, respectively, (the "Affected Periods"), including restated financial statements for the Affected Periods, to reflect adjustments to previously reported financial information. Please see the Company's separately filed Form 10-Q/As for more information about the restatement adjustments recorded.


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Critical Accounting Policies and Estimates

The discussion of the financial condition and the results of operations are based on the Consolidated Financial Statements, which have been prepared in conformity with United States generally accepted accounting principles. As such, management is required to make certain estimates, judgments and assumptions that are believed to be reasonable based on the information available. These estimates and assumptions affect the reported amount of assets and liabilities, revenue and expenses, and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, the most important and pervasive accounting policies used and areas most sensitive to material changes from external factors. See Note 2, "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements for additional discussion of the application of these and other accounting policies.

Segments

On March 1, 2011, the Company completed its acquisition of Choice Environmental Services, Inc. ("Choice"), a Florida based company that provides a complete range of solid waste and recycling collection, transportation, processing and disposal services. As a result of the acquisition of Choice, the Company operated in two segments: Hygiene and Waste. During the quarter ended June 30, 2012, the Company's Board of Directors determined to sell its Waste segment. On November 15, 2012, the Company completed a stock sale of Choice and other acquired businesses, including Lawson Sanitation LLC, Central Carting Disposal, Inc., and FSR Transporting & Crane Services, Inc. that comprise the Waste segment, to Waste Services of Florida, Inc. for $123.3 million. As discussed in Note 3, "Discontinued Operations and Sale of Waste Segment," in the Notes to the Consolidated Financial Statements, the Company has applied discontinued operations accounting treatment and disclosures for this transaction. As a result of the sale of Choice and all of its operations in the Waste segment, the Company's continuing operations are classified in one business segment, Hygiene.

Valuation Allowance for Accounts Receivable

We estimate the allowance for doubtful accounts for accounts receivable by considering a number of factors, including overall credit quality, age of outstanding balances, historical write-off experience and specific account analysis that projects the ultimate collectability of the outstanding balances. Actual results could differ from these assumptions. Our allowance for doubtful accounts was $2.3 million and $2.2 million as of December 31, 2012 and 2011, respectively.

Purchase Accounting for Business Combinations

The Company acquired four independent businesses and purchased the remaining non-controlling interest in one of its subsidiaries during the year ended December 31, 2012 and acquired sixty-three franchises and independent businesses during the year ended December 31, 2011. The Company accounts for these acquisitions by allocating the fair value of the consideration transferred to the fair value of the assets acquired and liabilities assumed on the date of the acquisition and any remaining difference is recorded as goodwill. Adjustments may be made to the preliminary purchase price allocation when facts and circumstances that existed on the date of the acquisition surface during the allocation period subsequent to the preliminary purchase price allocation, not to exceed one year from the date of acquisition. Contingent consideration is recorded at fair value based on the facts and circumstances on the date of the acquisition and any subsequent changes in the fair value are recorded through earnings each reporting period. Transactions that occur in conjunction with or subsequent to the closing date of the acquisition are evaluated and accounted for based on the facts and substance of the transactions.

Goodwill and Intangible Assets

Goodwill represents the excess of the cost of an acquired business over the fair value of the identifiable tangible and intangible assets purchased and liabilities assumed in a business combination. Identifiable intangible assets include customer relationships, non-compete agreements, trade names, trademarks and formulas. The fair value of these intangible assets at the time of acquisition is estimated based upon various valuation techniques including replacement costs and discounted future cash flow projections. Goodwill and intangible assets deemed to have indefinite lives are not amortized. Customer relationships are amortized on a straight-line basis over the expected average life of the acquired accounts, which is typically five to ten years based upon a number of factors, including longevity of customers, contracts acquired and historical retention rates. The non-compete agreements are amortized on a straight-line basis over the term of the agreements, typically not exceeding five years. Formulas are amortized on a straight-line basis over twenty years. Trademarks and trade names are considered to be indefinite lived intangible assets unless specific evidence exits that a shorter life is more appropriate.


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The Company tests goodwill and other indefinite-lived intangible assets for impairment annually, or more frequently, if indicators for potential impairment exist. Impairment testing is performed at the reporting unit level at December
31. Under generally accepted accounting principles, a reporting unit is either the equivalent to, or one level below, an operating segment. The test to evaluate for impairment begins with an assessment of qualitative factors to determine whether the existence of events and circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying value of the reporting unit. If the fair value of the reporting unit is less than its carrying value, we will perform a second step to determine the implied fair value of goodwill associated with that reporting unit. If the carrying value of goodwill exceeds the implied fair value of goodwill, such excess represents the amount of goodwill impairment.

Determining the fair value of a reporting unit includes the use of significant estimates and assumptions. Management utilizes a discounted cash flow technique as a means for estimating fair value. This discounted cash flow analysis requires various judgmental assumptions including those about future cash flows, customer growth rates and discount rates. Expected cash flows are based on historical customer growth, including attrition, and continued long term growth of the business. The discount rates used for the analysis reflect a weighted average cost of capital based on industry and capital structure adjusted for equity risk and size risk premiums. These estimates can be affected by factors such as customer growth, pricing, and economic conditions that can be difficult to predict. The Company also looks at competitors from a market perspective and recent transactions, if they exist, to confirm the results of the discounted cash flow fair value estimate.

As part of this impairment testing, management also assesses the useful lives assigned to its separately identifiable finite lived intangible assets. Management utilized a discounted cash flow technique to estimate the initial fair value of separately identifiable intangible assets. Expected cash flows were based on historical customer growth, including attrition, continued long-term growth of the business, and the business use of the related assets. Management therefore periodically reviews the performance of acquired customers in relation to the assumptions used to estimate the original value for these assets. Discount rates used for the initial analysis reflect a weighted average cost of capital based on industry and capital structure adjusted for equity risk and size risk premiums. During the years ended December 31, 2012, 2011, and 2010, intangible asset impairment losses of $0.5 million, $0.0 million and $0.0 million respectively, were recognized.

A hypothetical 10% decrease in the fair value of our reporting units as of December 31, 2012 would have no impact on the carrying value of our goodwill.

Long-lived Assets

We recognize losses related to the impairment of long-lived assets when the carrying amount is not recoverable and exceeds its fair value. When facts and circumstances indicate that the carrying values of long-lived assets may be impaired, our management evaluates recoverability by comparing the carrying value of the assets to projected future cash flows, in addition to other qualitative and quantitative analyses. We also continue to accumulate and analyze data regarding the operating performance of certain assets and their useful lives which have the potential to impact the amount of depreciation expense recorded in our statement of operations. This analysis, during 2011, indicated that certain assets will continue to be used in the business for different periods than originally anticipated. As a result, the Company revised the estimated useful lives of certain property and equipment effective on January 1, 2011. Had this change taken place January 1, 2010, depreciation expense would have decreased by $0.8 million for the year ended December 31, 2010. See Note 2, "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements for further discussion.

Revenue Recognition

Revenue from product sales and service is recognized when services are performed or the product is delivered to the customer. The Company may enter into multiple deliverable agreements with customers that outline the scope and frequency of services to be provided as well as the consumable products to be delivered. These deliverables are considered to be separate units of accounting as defined by ASC 605-25-Revenue Recognition-Multiple-Element Arrangements. The timing of the delivery and performance of service is concurrent and ongoing and there are no contingent deliverables.


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The Company's sales policies provide for limited rights of return on specific products for limited time periods. Product returns have been historically insignificant. The Company records estimated reductions to revenue for customer programs and incentive offerings, including pricing arrangements, promotions and other volume-based incentives at the time the sale is recorded. The Company also records estimated reserves for anticipated uncollectible accounts and for product returns and credits at the time of sale.

The Company has entered into franchise and license agreements which grant the exclusive rights to develop and operate within specified geographic territories for a fee. The initial franchise or license fee is deferred and recognized as revenue when substantially all significant services to be provided by the Company are performed. Direct incremental costs related to franchise or license sales for which revenue has not been recognized is deferred until the related revenue is recognized. Franchise and other revenue include product sales, royalties and other fees charged to franchisees in accordance with the terms of their franchise agreements. Royalties and fees are recognized when earned.

Income Taxes

Effective on January 1, 2007, Swisher International's shareholders elected that the corporation be taxed under the provisions of Subchapter S of the Internal Revenue Code of 1986, as amended (the "Code"). Under this provision, the shareholders were taxed on their proportionate share of Swisher International's taxable income. As a Subchapter S corporation, Swisher International bore no liability or expense for income taxes.

Due to the Merger in November 2010, Swisher International converted from a corporation taxed under the provisions of Subchapter S of the Internal Revenue Code ("S Corp") to a tax-paying entity and accounts for income taxes under the asset and liability method. The undistributed earnings on the date the Company terminated the S Corp election were recorded as additional paid-in capital on the Consolidated Financial Statements since the termination of the S Corp election assumes a constructive distribution to the owners followed by a contribution of capital to the corporation.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets where it is more likely than not that deferred tax assets will not be realized.

We include interest and penalties accrued in the Consolidated Financial Statements as a component of interest expenses. No significant amounts were required to be recorded as of December 31, 2012, 2011 and 2010. As of December 31, 2012, tax years of 2007 through 2011 remain open to inspection by the Internal Revenue Service.

Stock Based Compensation

We measure and recognize all stock based compensation at fair value at the date of grant and recognize compensation expense over the service period for awards expected to vest. Determining the fair value of stock based awards at the grant date requires judgment, including estimating the share volatility, the expected term the award will be outstanding, and the amount of the awards that are expected to be forfeited. We utilize the Black-Scholes option pricing model to determine the fair value. See Note 12, "Equity Matters" in the Notes to Consolidated Financial Statements for further information on these assumptions.


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Actuarially Determined Liabilities

We administer a defined benefit plan for certain retired employees (the "Plan"). The Plan has not allowed for new participants since October 2000. The measurement of our pension obligation is dependent on a variety of assumptions determined by management and used by our actuaries. Significant actuarial assumptions used in determining the pension obligation include the discount rate applied to the Plan obligation and expected long-term rate of return on the Plan's assets. The discount rate assumption is calculated using a bond yield curve constructed from a population of high-quality, non-callable corporate bonds. The discount rate is calculated by matching the Plan's projected cash flows to the yield curve. The expected return on Plan assets reflects asset allocations, investment strategies, and actual historical returns. Changes in benefit obligations associated with these assumptions may not be recognized as costs on the statement of income. Differences between actuarial assumptions and actual Plan results are deferred in Accumulated other comprehensive (loss) income and are amortized into cost only when the accumulated differences exceed 10% of the greater of the projected benefit obligation or the market value of the related Plan assets. We recognize the funded status of the Plan on the Consolidated Balance Sheet with the offsetting entry to Accumulated other comprehensive (loss) income.

The Plan assets are invested in U.S. equities, non-U.S. equities, and fixed income securities. Investment securities are exposed to various risks, including interest rate risk, credit risk, and overall market volatility. As a result of these risks, it is reasonably possible that the market values of investment securities could increase or decrease in the near term. Increases or decreases in market values could affect the current value of the Plan assets and, as a result, the future level of net periodic benefit cost.

Expected rate of return on Plan assets was developed by determining projected returns and then applying these returns to the target asset allocations of the Plan assets, resulting in a weighted average rate of return on Plan assets.

A one percent decrease in the discount rate assumption of 3.74% would result in an increase in the projected benefit obligation at December 31, 2012 of approximately $0.5 million. Based on the actuarial report as of December 31, 2012, we expect to make a minimum regulatory funding contribution of $22,000 during 2012.

Recently Adopted Accounting Pronouncements

Fair Value: In May 2011, the FASB issued updated accounting guidance on fair value measurements. The updated guidance resulted in common fair value measurement and disclosure requirements between U.S. GAAP and IFRS. The Company adopted this guidance effective January 1, 2012. The adoption did not have a material impact on the disclosures of the Company's consolidated financial information.

Comprehensive Income: In June 2011 and subsequently amended in December 2011, the FASB issued final guidance on the presentation of comprehensive income. Under the newly issued guidance, net income and comprehensive income may only be presented either as one continuous statement or in two separate but consecutive statements. The Company adopted this guidance effective January 1, 2012, with net loss and comprehensive loss shown as one continuous statement.

Newly Issued Accounting Pronouncements

Comprehensive Income: In February 2013, the FASB issued ASU 2013-02 which requires companies to provide information about the amounts reclassified out of accumulated other comprehensive income component ("AOCI"). In addition, companies are required to present, either on the face of the statement where net income is presented or in the accompanying notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, companies are required to cross-reference to other disclosures that provide additional detail on those amounts. ASU 2013-02 is effective prospectively for reporting periods beginning after December 15, 2012. The Company is evaluating this accounting standard update and does not expect it to have a significant impact on its financial statement disclosure.


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RESULTS OF OPERATIONS

The following table provides our results of operations for each of the years ended December 31, 2012, 2011, and 2010, including key financial information relating to our business and operations. This financial information should be read in conjunction with our audited Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 8.

                                                                       Year ended December 31,
                                                          2012                  2011                  2010
                                                           (In thousands except share and per share data)
Revenue
Products                                             $       202,968       $       131,109       $        37,690
Services                                                      26,186                26,107                17,737
. . .
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