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SGC > SEC Filings for SGC > Form 10-Q on 25-Apr-2014All Recent SEC Filings

Show all filings for SUPERIOR UNIFORM GROUP INC

Form 10-Q for SUPERIOR UNIFORM GROUP INC


25-Apr-2014

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, 2013. 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, 2013. 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 $235,000.

Inventories

Inventories are stated at the lower of cost or market value. Judgments and estimates are used in determining the likelihood that new goods on hand can be sold to customers. Historical inventory usage and current revenue trends are considered in estimating both excess and obsolete inventories. If actual product demand and market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Goodwill

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 environment in which the Company operates, an increased competitive environment, a decline in market-dependent multiples or metrics (considered in both absolute terms and relative to peers), a change in the market for the Company's products or services, or a regulatory or political development;


cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows;
overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods;
other relevant entity-specific events such as changes in management, key personnel, strategy, or customers;

Goodwill is tested at a level of reporting referred to as "the reporting unit." The Company's reporting units are defined as each of its two reporting segments with all of its goodwill included in the Uniforms and Related Products segment.

An entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines 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. The Company completed its assessment of the qualitative factors as of December 31, 2013 and determined that it was not more likely than not that the fair value of the reporting unit was less than its carrying value.

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 plans 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.

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 2014 and 2013 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 and restricted stock awards that vest three years from the date of grant, provided the grantee remains employed at the vesting date. The fair value of these restricted stock awards is equal to the market price of our common stock on the date of grant. Compensation expense is being recognized on a straight-line basis over the requisite three year service period. 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.


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 2 to the consolidated interim 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 the Company's 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.

We are continuing to increase our market penetration in our HPI division and our current backlog of business at HPI and the remainder of our Uniforms and Related products segment are at historically high levels. We expect to report significant increases in net sales and earnings beginning in the second quarter of 2014.

Remote Staffing Solutions

Our Remote Staffing Solutions 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 and 2013 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 and have continued to grow at an accelerated rate in first quarter 2014. We are aggressively marketing this service and we believe this sector will continue to grow significantly in the balance of 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 or early in 2015 and is expected to have a total cost of approximately $7 million.

Results of Operations

Net sales increased 32.4% from $30,985,000 for the three months ended March 31, 2013 to $41,027,000 for the three months ended March 31, 2014. The increase in net sales for the quarter is split between growth in our Uniforms and Related Products segment (30.4%) 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 Interim Consolidated Financial Statements for more information and a reconciliation of segment net sales to total net sales.

Uniforms and Related Products net sales increased 31.7% for the three months ended March 31, 2014. The primary reason for the increase in net sales was the inclusion of HPI's financial results in the Company's results of operations for the quarter ended March 31, 2014. Because HPI was acquired at the beginning of the third quarter 2013, its results of operations are not included in the Company's financial statements for the quarter ended March 31, 2013. Partially offsetting the effect of HPI's financial results was a $1,282,000 decrease in our sales of existing uniforms and related products in the first quarter 2014. This decrease was partially attributed to difficult weather conditions experienced in the first quarter 2014 that hampered our customers' business activities as well as our own operations at the end of the quarter.


We ended the quarter with a very strong backlog of orders and expect to see significant improvements in our net sales beginning in the second quarter.

Remote Staffing Solutions net sales increased 25.9% before intersegment eliminations and 48.3% after intersegment eliminations for the three months ended March 31, 2014, compared to the prior year quarter. This increase is attributed primarily to continued market penetration in 2014, both with respect to new and existing customers.

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products segment was 66.7% for the three months ended March 31, 2014 and 64.5% for the comparable period in 2013. The increase as a percentage of net sales is attributed to an increase in direct product costs as a percentage of net non-HPI sales for the quarter ended March 31, 2014 (0.8%), due primarily to competitive pricing factors in the market, an increase in overhead costs as a percentage of net sales as a result of lower volume in the current period (0.2%), and an increase in actual overhead costs in the current period (0.4%). Additionally the overall percentage was impacted by the fact that HPI cost of sales as a percentage of net sales are higher than non-HPI cost of sales (0.8%).

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions Segment was 42.6% for the three months ended March 31, 2014, and 37.2% in the comparable period for 2013. The percentage increase in 2014 as compared to 2013 is primarily attributed to taking on new startup accounts in the 2014 period.

As a percentage of net sales, selling and administrative expenses for our Uniforms and Related Products segment was 29.8% for the three months ended March 31, 2014 and 31.4% in the comparable period for 2013. Exclusive of HPI net sales and selling and administrative expenses, selling and administrative expenses as a percentage of net sales would have been 30.5% for the quarter ended March 31, 2014. The decrease as a percentage of sales, exclusive of HPI, is attributed primarily to lower incentive compensation expense as a result of higher earnings targets in the current year (1.0%), lower pension and retirement plan expense as a result of the freeze of our main defined benefit pension plan effective June 30, 2013 (0.5%) and other minor net decreases (1.5%), partially offset by higher share-based compensation expense (0.8) and the impact of lower net sales to cover operating expenses (1.3%). HPI selling and administrative expenses as a percentage of HPI net sales was 27.9% for 2014 including amortization of intangible assets associated with the acquisition (4.5%).

As a percentage of net sales, selling and administrative expenses for our Remote Staffing Solutions segment was 35.5% for the three months ended March 31, 2014 and 37.8% for the comparable period for 2013. The decrease as a percentage of sales is attributed primarily to a decrease in salaries, wages and benefits as a percentage of net sales (0.4%) as the growth in net sales outpaced the increase in staffing expense required to support significant growth of this segment, and other miscellaneous decreases including higher net sales to cover fixed operating expenses (2.2%), partially offset by increased outside broker fees as the Company supplemented its internal sales efforts with independent brokers in 2014 (0.3%).

Interest expense increased from $7,000 for the three months ended March 31, 2013 to $95,000 for the three months ended March 31, 2014. This increase is attributed to the increased borrowings to fund the acquisition of HPI as well as increased borrowings on our revolver to fund increased inventory levels in preparation for several significant new accounts being rolled out in the second and third quarters of 2014.

The Company's effective tax rate for the three months ended March 31, 2014 was 35.1% versus 29.7% for the three months ended March 31, 2013. The 5.4% increase in the effective tax rate is attributed primarily to a decrease in the benefit for untaxed foreign income (3.2%), increased provisions for uncertain tax positions (1.6%), and other items (0.6%).

Liquidity and Capital Resources

Accounts receivable - trade increased 3.2% from $22,735,000 on December 31, 2013 to $23,467,000 on March 31, 2014 primarily due to an increase in net sales in the month of March 2014 in comparison to the month of December 2013.

Prepaid expenses and other current assets increased 24.3% from $6,012,000 on December 31, 2013 to $7,472,000 as of March 31, 2014. This increase is primarily attributed to an increase in deposits paid to vendors of $1,001,000 for upcoming inventory purchases in preparation for several large rollouts of customer programs that are expected to begin shipping in the second quarter of 2014 and a $487,000 increase in prepaid insurance due to timing of payments of annual premiums.

Inventories increased 10.5% from $49,486,000 on December 31, 2013 to $54,692,000 as of March 31, 2014 in preparation for the rollouts disclosed above.

Other intangible assets decreased 2.8% from $18,353,000 on December 31, 2013 to $17,837,000 on March 31, 2014. This decrease is attributed to scheduled amortization of existing intangible assets.


Accounts payable increased 17.6% from $8,363,000 on December 31, 2013 to $9,839,000 on March 31, 2014. This increase is primarily attributed to the increase in inventory levels as discussed above.

Other current liabilities decreased 50.2% from $7,768,000 on December 31, 2013 to $3,868,000 on March 31, 2014. This decrease is primarily due to the payment of year-end annual incentive compensation during the first quarter of the year.

Cash and cash equivalents decreased by $902,000 from $5,316,000 on December 31, 2013 to $4,414,000 as of March 31, 2014. During the first quarter of 2014, the Company used cash of $7,257,000 in operating activities, used cash of $734,000 in investing activities primarily related to fixed asset additions, and generated $7,089,000 from financing activities. The financing activities consisted of normal amortization payments on the existing term loan offset by net borrowings under the revolving credit agreement of $7,930,000. These borrowings were required in order to support the increased working capital requirements associated with the large customer programs that are expected to begin shipping in the second quarter of 2014.

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, 2014 and 2013, respectively, the Company paid cash dividends of $833,000 and $-0-.

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 as discussed in Note 2 to the consolidated interim financial statements. 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 (1.2% at March 31, 2014). 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 March 31, 2014, 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 March 31, 2014, the interest rate swap had a negative fair value of $154,000, which is presented within other current liabilities within the Consolidated Balance Sheet. The aggregate change of $154,000, net of tax benefit of $55,000, since the inception of the hedge in July 2013 has been recorded within OCI through March 31, 2014. 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 $1,500,000; 2015 $2,625,000; 2016 $3,000,000; 2017 $3,000,000; and 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.


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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