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SGC > SEC Filings for SGC > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for SUPERIOR UNIFORM GROUP INC

Form 10-K for SUPERIOR UNIFORM GROUP INC


28-Feb-2014

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, since 2009 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 have been actively pursuing acquisitions to increase our market share in the Uniforms and Related Products segment. As discussed in Note 16 to the consolidated financial statements, the Company completed the acquisition of substantially all of the assets of HPI Direct, Inc. on July 1, 2013. Second, we diversified our business model to include the Remote Staffing Solutions segment. This business segment was initially started to provide these services for the Company at a lower cost structure in order to improve our own operating results.

Uniforms and Related Products

Historically, we have manufactured and sold a wide range of uniforms, career apparel and accessories, which comprises our Uniforms and Related Products segment. As noted above, we are actively pursuing acquisitions to increase our market share in the Uniforms and Related Products business and it is our intention to continue to seek additional acquisitions that fit into this business in the future.

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 2012 margins began to show improvement in comparison to the first three quarters of 2012 and this trend continued to improve significantly during 2013. This situation appears to have stabilized and our margins have returned to historically normal levels.

Remote Staffing Solutions

This segment, located in El Salvador, Belize, and the United States, has enabled us to reduce our operating expenses in our Uniforms and Related Products segment and to more effectively service our customers' needs in that segment. 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 $5.7 million in net sales to outside customers in 2013. We spent significant effort in 2012 improving our management infrastructure in this segment to support significant growth in this segment in 2013 and beyond. Net sales to outside customers in this segment increased by approximately 63% in 2013 as compared to 2012. We are aggressively marketing this service and we believe this sector will continue to grow significantly in 2014 and beyond. We expect to make a significant investment in a new building to service our El Salvador location in 2014. This project is expected to be completed late in 2014 and is expected to have a total cost in excess of $7 million.

Operations



Net Sales



                                    2013              2012           % Change
Uniforms and Related Products   $ 145,846,000     $ 116,029,000           25.7 %
Remote Staffing Solutions           9,285,000         7,196,000           29.0 %
Net intersegment eliminations      (3,635,000 )      (3,739,000 )         -2.8 %
Consolidated Net Sales          $ 151,496,000     $ 119,486,000           26.8 %


Net sales increased 26.8% from $119,486,000 in 2012 to $151,496,000 in 2013. The increase in net sales is split between growth in our Uniforms and Related Products segment (25.0%) and increases in net sales after intersegment eliminations from our Remote Staffing Solutions segment (1.8%). Intersegment eliminations reduced total net sales for sales of the Remote Staffing Solutions segment to the Uniforms and Related Products segment.

Uniforms and Related Products net sales increased 25.7% in 2013. Net sales for HPI, from July 1, 2013, the date of acquisition, through December 31, 2013 were $21,052,000. This represented an increase 36.0% versus their net sales for the comparable period in 2012. This accounted for 18.1 points of the 25.7% increase in net sales with the remaining increase in net sales for this segment attributed primarily to increased market penetration.

Remote Staffing Solutions net sales increased 29.0% before intersegment eliminations and 63.4% after intersegment eliminations in 2013. These increases are attributed primarily to continued market penetration in 2013.

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products Segment was 66.2% in 2013 and 67.4% in 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 on non HPI sales during the current period (1.4%) due to lower raw material costs primarily related to the impact of shortages of cotton in 2012, a reduction in overhead costs as a percentage of net sales as a result of higher volume in the current period (0.2%) partially offset by higher cost of goods sold on HPI sales as a percentage of net sales (0.4%).

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions Segment was 38.4% in 2013, and 40.9% in 2012. The percentage decrease in 2013 as compared to 2012 is primarily attributed to a shift of business between our previous call center in Costa Rica and our newest location in Belize.

As a percentage of net sales, selling and administrative expenses for our Uniforms and Related Products Segment approximated 29.4% in 2013 and 29.2% in 2012. Exclusive of HPI net sales and selling and administrative expenses, selling and administrative expenses as a percentage of net sales would have been 29.7%. The increase as a percentage of sales, exclusive of HPI, is attributed primarily to higher incentive compensation expense as a result of higher earnings (1.8%), settlement loss related to pension plans in the current year (0.4%), transaction expenses associated with the acquisition of HPI (0.8%), partially offset by the impact of higher net sales to cover operating expenses (2.2%), 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%) and minor increases in various other costs (0.1%). HPI selling and administrative expenses as a percentage of HPI net sales was 27.2% for 2013 including amortization of intangible assets associated with the acquisition (4.6%).

During the fourth quarter of 2012, 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. There were no such charges in 2013.

As a percentage of net sales, selling and administrative expenses for our Remote Staffing Solutions Segment approximated 37.0% in 2013 and 32.9% in 2012. The increase as a percentage of sales is attributed primarily to an increase in salaries, wages and benefits (2.3%) 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 (1.6%) and other miscellaneous increases (0.2%).

The effective income tax rate in 2013 was 31.1% and in 2012 was 34.4%. The 3.3% decrease in the effective tax rate is attributed primarily to the following: a decrease in the state income tax rate (0.7%), a decrease in the accrual for uncertain tax positions (0.9%), a decrease due to a non-deductible portion of intangible asset impairment (1.8%), a decrease from the impact of permanent differences between book and tax basis earnings related to share-based compensation (2.3%), and a decrease in the impact of other items (0.7%) partially offset by a decrease in the benefit for untaxed foreign income (3.1%). During the years ended December 31, 2013 and 2012, the Company did not recognize deferred income taxes on foreign income of $1,688,000 and $1,437,000, 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 2014 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, 2013. As of December 31, 2013, approximately $3,326,000 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 - trade increased 36.5% from $16,655,000 on December 31, 2012 to $22,735,000 as of December 31, 2013. The Company acquired $4,672,000 of accounts receivable as part of the acquisition of HPI on July 1, 2013. The remainder of the increase is attributed to increased net sales in the current period.

Accounts receivable - other increased 38.0% from $2,995,000 on December 31, 2012 to $4,133,000 as of December 31, 2013. This increase is attributed to higher levels of raw materials held at our supplier in Haiti to support increased volume of goods being purchased to support higher sales levels. The Company purchases raw materials on behalf of its supplier and records a receivable from the supplier on its books. The cost of these raw materials are deducted from payments to the supplier when finished goods are delivered to the Company.

Prepaid expenses and other current assets increased 115.2% from $2,794,000 on December 31, 2012 to $6,012,000 as of December 31, 2013. The Company acquired $1,096,000 of prepaid expenses and other current assets as part of the acquisition of HPI on July 1, 2013. The balance of the increase is primarily attributed to higher levels of deposits paid to suppliers for inventory purchases. The level of inventory purchases on order is to meet future sales demand.

Inventories increased 26.1% from $39,246,000 on December 31, 2012 to $49,486,000 as of December 31, 2013. The Company acquired $10,374,000 of inventory as part of the acquisition of HPI on July 1, 2013.

Other intangible assets increased from $559,000 to $22,488,000. As part of the acquisition of HPI on July 1, 2013, the Company recorded $18,900,000 of other intangible assets consisting of acquired customer relationships of $9,200,000; a non-compete agreement of $5,000,000; and an acquired trade name for $4,700,000.The acquired customer relationships are being amortized over a ten year period. The non-compete agreement is being amortized over its five year life. The trade name is considered to be an indefinite life asset and is not being amortized. These increases are offset by normal amortization of the newly acquired items above in addition to amortization of the previously existing intangibles.

The Company also recorded $4,135,000 of goodwill as a result of the acquisition of HPI.

Accounts payable increased 26.2% from $6,629,000 on December 31, 2012 to $8,363,000 on December 31, 2013. The Company did not assume any accounts payable as part of the acquisition of HPI on July 1, 2013. Accounts payable for HPI for purchases and expenses after the acquisition resulted in an accounts payable balance for HPI of $2,113,000 as of December 31, 2013. The remainder of the fluctuation is not considered significant.

Other current liabilities increased 141.1% from $3,222,000 on December 31, 2012 to $7,768,000 on December 31, 2013. This increase is primarily due to increased accruals for incentive compensation as a result of improved operating results of $2,242,000; accrued payroll and incentive compensation for HPI employees of $417,000; other accrued expenses for HPI of $1,461,000; $125,000 accrued loss relative to the interest rate swap entered into during the third quarter of 2013 and $301,000 of other miscellaneous increases.

Long-term pension liability decreased 65.4% from $10,468,000 on December 31, 2012 to $3,617,000 on December 31, 2013. This decrease is attributed to the following items. Effective June 30, 2013, the Company no longer accrues additional benefits for future service or for future increases in compensation levels for the Company's primary defined benefit pension plan. As a result of this change, the Company re-measured its pension obligations as of June 30, 2013 and the Company recognized a curtailment gain of $1,990,000 and a corresponding reduction in the long-term pension liability. Additionally there were actuarial gains recognized in the current year that reduced the obligation balance by $2,810,000 and actual return on plan assets exceeded the service cost and interest recognized by $1,051,000. Additionally, the Company contributed $1,000,000 to its pension plans in the current year.

As part of its acquisition of HPI in the current year, the Company recorded a liability for an acquisition related contingent liability. This amount will be earned by the former owners of HPI based upon the performance of HPI following the acquisition for each of the years from 2014 through 2017. The total amount of this liability expected to be paid is $7,200,000. This liability was discounted to recognize the time value of the liability. The liability will be increased each year to reflect the interest component of this liability. The increase is being recorded through other expense in selling and administrative expense in the consolidated statement of comprehensive income.


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, 2013, the working capital of the Company was approximately $69,801,000 and the working capital ratio was 4.9:1. 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, excluding the HPI acquisition, were approximately $1,631,000 and $1,647,000 in 2013 and 2012, respectively. We expect to make a significant investment in a new building to service our El Salvador location of our Remote Staffing segment in 2014. This project is expected to be completed late in 2014 and is expected to have a total cost in excess of $7 million.

During the years ended December 31, 2013 and 2012, the Company paid cash dividends of approximately $874,000 and $6,574,000, respectively. 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 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. During 2013, the Company restarted its regular quarterly dividend of $0.135 per share one quarter early and paid this dividend during the fourth quarter of 2013.

On August 1, 2008, the Company's Board of Directors reset the common stock repurchases 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 13,211 shares and 36,570 shares of its common stock in the years ended December 31, 2013 and 2012, respectively, with approximate costs of $162,000 and $437,000, respectively. At December 31, 2013, the Company had 261,675 shares remaining for purchase under its common stock repurchases 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 2013, cash and cash equivalents increased by approximately $1,762,000. $8,401,000 in cash was provided by operating activities, $34,100,000 was used in investing activities with $32,483,000 related to the acquisition of HPI and the balance primarily related to fixed asset additions of $1,631,000, and $27,461,000 was provided by financing activities. Financing activities included the borrowing of $30,000,000 for a term loan for the acquisition of HPI. The Company paid down the term loan by $3,000,000 in addition to required amortization of the loan using excess cash generated from operations. Financing activities also included the reacquisition and retirement of shares of the Company's common stock of $162,000, and the payment of dividends of $874,000, partially offset by proceeds received from the exercise of stock options of $2,216,000.

Effective July 1, 2013, the Company entered into an amended and restated 5-year credit agreement with Fifth Third Bank that made available to the Company up to $15,000,000 on a revolving credit basis in addition to a $30,000,000 term loan utilized to finance the acquisition of substantially all of the assets of HPI Direct, Inc. as discussed in Note 7. Interest is payable on both the revolving credit agreement and the term loan at LIBOR (rounded up to the next 1/8th of 1%) plus 0.95% based upon the one-month LIBOR rate for U.S. dollar based borrowings (1.20% at December 31, 2013). The Company pays an annual commitment fee of 0.10% 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, 2013, there were no balances outstanding under letters of credit.

On October 22, 2013, the credit agreement was amended to, among other things, increase the amount of permitted investments in subsidiaries that are not parties to the credit and related agreements, from $1 million to $5 million.

In order to reduce interest rate risk on the term loan, the Company entered into an interest rate swap agreement with Fifth Third Bank, N.A. in July 2013 that was designed to effectively convert or hedge the variable interest rate on a portion of this borrowing to achieve a net fixed rate of 2.53% per annum, beginning July 1, 2014 with a notional amount of $14,250,000 that is adjusted to match the outstanding principal on the related debt. The notional amount of the interest rate swap is reduced by the scheduled amortization of the principal balance of the term loan of $187,500 per month through July 1, 2015 and $250,000 per month through June 1, 2018. The remaining notional balance of $3,250,000 will be eliminated at the maturity of the term loan on July 1, 2018.


Under the terms of the interest rate swap, the Company will receive variable interest rate payments and make fixed interest rate payments on an amount equal to the notional amount at that time. Changes in the fair value of the interest rate swap designated as the hedging instrument that effectively offset the variability of cash flows associated with the variable-rate, long-term debt obligation are reported in OCI, net of related income tax effects. At December 31, 2013, the interest rate swap had a negative fair value of $125,000, which is presented within other current liabilities within the Consolidated Balance Sheet. The entire change of $125,000, net of tax benefit of $40,000, since the inception of the hedge in July 2013 has been recorded within OCI for the year ended December 31, 2013. The Company does not currently expect any of those losses to be reclassified into earnings over the subsequent twelve-month period.

The remaining scheduled amortization for the term loan is as follows: 2014 $1,750,000; 2015 $2,625,000; 2016 $3,000,000; 2017 $3,000,000; 2018 $15,875,000. The term loan does not include a prepayment penalty. In connection with the credit agreement, the Company incurred approximately $68,000 of debt financing costs, which primarily consisted of legal fees. These costs are being amortized over the life of the credit agreement and are recorded as additional interest expense.

The amended and restated credit agreement with Fifth Third Bank is secured by substantially all of the operating assets of Superior Uniform Group, Inc. and is guaranteed by all domestic subsidiaries of Superior Uniform Group, Inc. The agreement contains restrictive provisions concerning a maximum funded senior indebtedness to EBITDA ratio as defined in the agreement (3.5:1), a maximum funded indebtedness to EBITDA ratio as defined in the agreement (4.0:1) and fixed charge coverage ratio (1.25:1). The Company is in full compliance with all terms, conditions and covenants of the credit agreement.

Long-Term Contractual
Obligations
                                                                       Payments Due by Period

                                                    One year          Two to          Four to         After five
                                     Total           or less       three years       five years          years
Long-term debt                    $ 26,250,000     $ 1,750,000     $  5,625,000     $ 18,875,000              -
Operating leases                        75,000          43,000           29,000            3,000              -
Interest payments (1)                1,609,000         358,000          817,000          434,000              -

Total long-term contractual
cash obligations                  $ 27,934,000     $ 2,151,000     $  6,471,000     $ 19,312,000     $           -

(1) Interest payments include both the fixed and variable rate portions of interest on the Company's term loan with Fifth Third Bank.

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 $227,000. The Company's concentration of risk is also monitored and at year-end 2013, no customer had an account balance greater than 10% of receivables and the five largest customer account balances totaled $6,264,000. 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 $4,018,000 at December 31, 2013. 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.

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. The Company tests goodwill for impairment annually as of December 31st and/or when an event occurs or circumstances change such that it is more likely than not that impairment may exist. Examples of such events and circumstances that the Company would consider include the following:

macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, or other developments in equity and credit markets;

industry and market considerations such as a deterioration in the . . .

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