SUPERIOR GROUP OF COMPANIES, INC. (SGC) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our Financial Statements, which present our results of operations for the years ended December 31, 2021, 2020 and 2019, as well as our financial positions at December 31, 2021 and 2020, contained elsewhere in this Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the “Special Note Regarding Forward Looking Statements” and “Risk Factors” sections of this Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
The discussion that follows includes a comparison of the Company’s results of operations and liquidity and capital resources for the years ended December 31, 2021 and 2020. For the discussion of changes from the year ended December 31, 2019 to the year ended December 31, 2020 and other financial information related to the year ended December 31, 2019, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, of the Company’s Form 10-K for the year ended December 31, 2020. That document was filed with the United States Securities and Exchange Commission on March 3, 2021.
Recent Acquisitions
On January 29, 2021, the Company, through BAMKO, acquired substantially all of the assets of Gifts By Design, Inc. (“Gifts by Design”) of Seattle, Washington. Gifts by Design is a promotional products and branded merchandise agency that is well-established as a developer and supplier of corporate awards, incentives, and recognition programs for some of the world’s biggest brands. The purchase price for the acquisition consisted of $6.0 million in cash at closing.
On December 2, 2021, the Company, principally through BAMKO, acquired substantially all of the assets of Sutter’s Mill Specialties, Inc. (“Sutter’s Mill”) of Tempe, Arizona. Sutter's Mill is a vertically integrated manufacturer of high quality, decorated promotional products. Sutter's Mill has the capability to print on demand and create customized promotional programs and products for customers of any size. The purchase price of the acquisition consisted of the following: (a) approximately $10.4 million in cash at closing, subject to a working capital adjustment, (b) the issuance of 45,620 restricted shares of Superior’s common stock that vest ratably over a three-year period, and (c) potential future payments of approximately $4.5 million in additional contingent consideration for calendar years 2022 through 2024 based on the results of the acquired business.
Business Outlook
Superior is comprised of three reportable business segments: (1) Uniforms and Related Products, (2) Remote Staffing Solutions, and (3) Promotional Products.
Uniforms and Related Products
In our Uniforms and Related Products segment, we manufacture and sell a wide range of uniforms, career apparel and accessories. Our primary products are service apparel, such as scrubs, lab coats, protective apparel and patient gowns, provided to the healthcare industry, and service apparel, such as uniforms, provided to workers employed by our customers in various industries, including retail, hotel, food service, transportation and other industries. We sell our brands of healthcare service apparel primarily to healthcare laundries, dealers, distributors and retailers. The COVID-19 pandemic initially created increased demand for healthcare service apparel from laundries, dealers and distributors that service hospitals and other medical facilities. From a long-term perspective, we expect that demand for our signature marketing brands, including Fashion Seal Healthcare® and WonderWink®, will continue to provide opportunities for growth and increased market share. Sales of uniforms are impacted by our customers’ opening and closing of locations and reductions, increases, and turnover of employees. The COVID-19 pandemic reduced demand for uniform apparel in many of our customers’ industries, such as the restaurant, transportation and hospitality industries. This, however, was partially offset by demand from customers in certain retail industries, such as grocery and pharmacy customers. The economic environment in the United States is beginning to return to pre-pandemic economic activity levels. While we continue to source some personal protective equipment for our customers, we anticipate that demand for personal protective equipment, including for our Uniforms and Related Products segment, will continue to decline. Based on the longer-term fundamentals of our uniforms business, however, we believe that we have growth opportunities to expand our market share.
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Remote Staffing Solutions
This business segment (also known as “The Office Gurus”), which operates in El Salvador, Belize, Jamaica, Dominican Republic, and the United States, initially started to support the Company’s back office needs while improving overall efficiencies and lowering operating costs. After years of consistently improving key performance indicators, lowering costs and providing exceptional service to our Uniforms and Related Products segment in areas such as order entry, cash collections, vendor payables processing, customer service, sales, and others, The Office Gurus started selling their services to outside companies in 2009. The Office Gurus has become an award-winning business process outsourcer offering inbound and outbound voice, email, text, chat and social media support. Although the COVID-19 pandemic has generated uncertainties for our customers and their industries, we have recently seen increased demand for our services. With an environment and career path designed to attract and maintain top talent across all sites, we believe The Office Gurus is positioned well to continue growing this business.
Promotional Products
For more than a decade, we sold promotional products on a limited basis to our existing Uniforms and Related Products customer base. While there were substantial opportunities to sell promotional products to those customers, it was not an area of focus, specialization, or expertise for us. On March 1, 2016, that changed with our acquisition of substantially all of the assets of BAMKO, Inc. (“BAMKO”). BAMKO has many strengths, well-developed systems, and time-tested processes that offer significant competitive advantages. With a robust back-office support platform operated out of India, direct-to-factory sourcing operations based in China, and proprietary technological platforms and programming capabilities that we believe are competitive, BAMKO is well positioned in the promotional products industry and continues to be a platform for potential future acquisitions. We completed two additional acquisitions in this segment in late 2017, as well as acquisitions in January 2021 and December 2021, and remain open to additional acquisitions going forward. In recent years we have seen an increase in customer orders in our promotional products business and expect growth opportunities for our core promotional products business to continue. The COVID-19 pandemic created significant opportunities for us within the personal protective equipment market. Although we will continue to source some personal protective equipment for our customers, we anticipate, based on supply and demand factors, that opportunities to supply personal protective equipment, including through our Promotional Products segment, will continue to decline. Our core promotional products business has not experienced the same downturn during the pandemic that many of our competitors experienced as increased activities from customers in certain industries, such as the delivery service industry, more than offset reduced activities from customers in other industries, such as the restaurant and entertainment industries. From a long-term perspective, we believe that this segment’s synergistic fit with our uniforms business will create opportunities to cross-sell the products of each of these business segments to new and existing customers.
COVID-19 Impact
The COVID-19 pandemic continues to affect our operations around the world and financial performance, and likely will continue to do so for an undetermined period of time. International, federal, state and local efforts to contain the spread of COVID-19 have continued. Government actions to address the situation remain in effect and new actions continue to be enacted or modified, including safety requirements such as recommended or mandatory use of face masks and other personal protective equipment and related products, recommended or mandated vaccinations, social distancing rules and guidelines, travel restrictions, temporary closures of non-essential businesses and other restrictive measures.
In responding to the needs of our customers, we have sourced personal protective equipment, including face masks, isolation gowns, sanitizers and gloves, which contributed $19.6 million and $19.0 million to net sales during the year ended December 31, 2021 for our Uniforms and Related Products segment and Promotional Products segment, respectively. Personal protective equipment net sales for our Promotional Products segment and Uniforms and Related Products segment were $82.7 million and $48.5 million, respectively, during the year ended December 31, 2020.
However, the pandemic also had and could continue to have a number of adverse impacts on our business, including, but not limited to, disruption to the economy and our customers’ willingness and/or ability to spend, temporary or permanent closures of businesses that consume our products and services, additional work restrictions, and supply chains being interrupted, slowed, or rendered inoperable. Our employees and the employees and contractors of our suppliers and customers also could become ill, quarantined, or otherwise unable to work or travel due to health reasons or governmental restrictions.
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Prolonged or recurring disruptions or instability in the United States and global economies, and how the world reacts to those disruptions or instability, could have long-term impacts on our business. These business impacts could negatively affect us in a number of ways, including, but not limited to, reduced demand for our core products and services, reductions to our revenue and profitability, costs associated with complying with new or amended laws and regulations affecting our business, declines in our stock price, reduced availability and less favorable terms of future borrowings, valuation of our pension obligations, reduced credit-worthiness of our customers, and potential impairment of the carrying value of goodwill or other indefinite-lived intangible assets. The extent to which the COVID-19 pandemic ultimately impacts our business, financial condition, results of operations or cash flows will depend on numerous factors that continue to evolve and which we may not be able to accurately predict at this time, including the delivery of effective vaccines on a timely basis to a number of people sufficient to prevent or substantially lower the severity of incidents of infection or possible future variants of the virus, the extent and effectiveness of containment actions, availability of widespread rapid testing and effective treatment alternatives. Prolonged or recurring periods of difficult market conditions could have material adverse impacts on our business, financial condition, results of operations and cash flows.
Sourcing of Goods and Raw Materials
Along with many manufacturers that source goods and raw materials from abroad, we are currently experiencing continued significant supply disruptions and delays due to a variety of reasons. These changes are partially driven by interruptions in global supply chains (including as a result of port congestion and trucking shortages) and partially by a shift in customer buying habits to e-commerce, which has the effect of increasing demand for shipping capacity from Asia, leading to capacity constraints. Both factors have increased shipping times as well as the price of shipping, whether by sea, air, rail, or vehicle, this year. Shipping delays combined with significant increases in orders for our products have recently created, and are expected to continue to create, inventory pressure for us.
An interruption in any of our supply sources or facilities could adversely affect our results of operations until alternate sources or facilities can be secured. The Uniforms and Related Products segment’s principal fabrics used in the manufacture of its finished goods are cotton, polyester, cotton-synthetic and poly-synthetic blends. The majority of such fabrics are sourced in China. The Promotional Products segment relies on the supply of different types of raw materials as well as textiles, including plastic, glass, fabric and metal. The vast majority of these raw materials are principally sourced from China, either directly by BAMKO or its suppliers. If we are unable to continue to obtain our raw materials and finished products from China or if our suppliers are unable to source raw materials from China, it could significantly disrupt our business. Further, the Company and the Company’s suppliers generally source or manufacture finished goods in parts of the world that may be affected by economic uncertainty, political unrest, logistical challenges (such as port strikes and embargos), foreign currency fluctuations, labor disputes, health emergencies, or the imposition of duties, tariffs or other import regulations by the United States, any of which could result in additional cost or limit our supply of necessary goods and raw materials.
We currently believe challenges created by such supply chain disruptions are manageable. However, we have limited insight into the extent to which COVID-19 or other factors could further impair our sourcing of goods and materials.
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The Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020
Operations
Net Sales (in thousands, except percentages):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | % Change | ||||||||||
| Uniforms and Related Products | $ | 263,933 | $ | 287,333 | (8.1 | %) | ||||||
| Remote Staffing Solutions | 64,312 | 42,365 | 51.8 | % | ||||||||
| Promotional Products | 215,842 | 202,156 | 6.8 | % | ||||||||
| Net intersegment eliminations | (7,101 | ) | (5,157 | ) | 37.7 | % | ||||||
| Consolidated Net Sales | $ | 536,986 | $ | 526,697 | 2.0 | % |
Net sales for the Company increased 2.0% from $526.7 million for the year ended December 31, 2020 to $537.0 million for the year ended December 31, 2021. The principal components of this aggregate increase in net sales were as follows: (1) a decrease in net sales for our Uniforms and Related Products segment (contributing (4.4%)), (2) an increase in net sales for our Remote Staffing Solutions segment after intersegment eliminations (contributing 3.8%) and (3) an increase in net sales for our Promotional Products segment (contributing 2.6%).
Uniforms and Related Products net sales decreased 8.1%, or $23.4 million, for the year ended December 31, 2021 compared to the year ended December 31, 2020. The decrease was primarily due to a decrease of $28.9 million in sales of personal protective equipment resulting from significantly lower volumes and lower market demand for healthcare service apparel when compared to the spike in demand during the early phases of the COVID-19 pandemic that began in the second quarter of 2020. These decreases were partially offset by an increase in demand for uniform apparel.
Remote Staffing Solutions net sales increased 51.8% before intersegment eliminations and 53.8% after intersegment eliminations for the year ended December 31, 2021 compared to the year ended December 31, 2020. These increases were primarily attributed to our providing continued services in 2021 to our customer base that was expanded during 2020, the onboarding of new customers in 2021 and the negative impact of disruptions experienced in 2020 resulting from COVID-19.
Promotional Products net sales increased 6.8%, or $13.7 million, for the year ended December 31, 2021 compared to the year ended December 31, 2020. The increase was primarily due to an increase of $77.4 million in net sales in our core promotional products business, partially offset by a decrease of $63.7 million in the sale of personal protective equipment. The increase in net sales in our core promotional products business was driven by the timing of promotional programs launched for certain customers, growth of our customer base through continued market penetration experienced in 2020 and 2021 and improved market conditions. Additionally, the acquisitions of Gifts by Design and Sutter's Mill in 2021 contributed $16.9 million to net sales for the year ended December 31, 2021. The robust personal protective equipment sales during the year ended December 31, 2020 were driven by market demand during the early phases of the COVID-19 pandemic.
Cost of Goods Sold
Cost of goods sold consists primarily of direct costs of acquiring inventory, including cost of merchandise, inbound freight charges, purchasing costs, and inspection costs for our Uniforms and Related Products and Promotional Products segments. Cost of goods sold for our Remote Staffing Solutions segment includes salaries and payroll related benefits for agents. The Company includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with out-bound freight are recorded in cost of goods sold. Other shipping and handling costs are included in selling and administrative expenses.
As a percentage of net sales, cost of goods sold for our Uniforms and Related Products segment was 67.4% for the year ended December 31, 2021 and 65.2% for the year ended December 31, 2020. The percentage increase was primarily driven by higher logistical costs and $2.0 million in inventory write-downs of personal protective equipment during the year ended December 31, 2021, partially offset by the decrease in personal protective equipment sales. Interruptions in global supply chains have led to higher logistical costs in 2021 and are expected to continue in 2022, however, the extent to which we will be impacted is dependent on a number of factors that are difficult to predict. For additional information related to logistical challenges, please refer to the section “ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Business Outlook – Sourcing of Goods and Raw Materials.”
As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions segment was 41.5% for the year ended December 31, 2021 and 42.6% for the year ended December 31, 2020. The percentage decrease was primarily driven by disruptions resulting from COVID-19 during the year ended December 31, 2020.
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As a percentage of net sales, cost of goods sold for our Promotional Products segment was 69.4% for the year ended December 31, 2021 and 66.5% for the year ended December 31, 2020. The percentage increase was primarily the result of differences in the mix of products and customers.
Selling and Administrative Expenses
Selling and administrative expenses increased 4.1%, or $5.6 million, for the year ended December 31, 2021 compared to the year ended December 31, 2020. The increase was primarily due to an increase in employee costs driven mostly by increased headcount and the effect of the Company’s decision in 2020 to forgo its discretionary matching contribution under its defined contribution plan, partially offset by a decrease in bad debt expense of $4.5 million on outstanding trade accounts receivable.
As a percentage of net sales, selling and administrative expenses for our Uniforms and Related Products segment was 28.9% for each of the years ended December 31, 2021 and 2020. As a percentage of net sales, selling and administrative expenses remained relatively flat.
As a percentage of net sales, selling and administrative expenses for our Remote Staffing Solutions segment was 36.9% for the year ended December 31, 2021 and 36.1% for the year ended December 31, 2020. As a percentage of net sales, selling and administrative expenses remained relatively flat.
As a percentage of net sales, selling and administrative expenses for our Promotional Products segment was 21.3% for the year ended December 31, 2021 and 20.5% for the year ended December 31, 2020. As a percentage of net sales, selling and administrative expenses remained relatively flat.
Other Periodic Pension Costs
Other periodic pension costs increased to $1.8 million for the year ended December 31, 2021 from $1.0 million for the year ended December 31, 2020. This increase was primarily due to actuarial losses recognized on the supplemental executive retirement plan (“SERP”) of $1.5 million during 2021 compared to actuarial losses recognized on the SERP of $0.7 million in 2020.
Pension Plan Terminations
During the year ended December 31, 2021, the Company completed the termination of its two noncontributory qualified defined benefit pension plans, which were fully funded. Consequently, the Company recognized a settlement charge of $7.8 million during the year ended December 31, 2021, which represents the acceleration of deferred charges previously included within accumulated other comprehensive loss, the impact of remeasuring the plan assets and obligations at termination and additional benefits from asset surpluses paid and expected to be paid to plan participants. The pension plan terminations did not require a cash outlay by the Company.
Gain on Sale of Property, Plant and Equipment
During the year ended December 31, 2020, the Company sold a building and related assets that were previously used as a Distribution Center within our Uniforms and Related Products segment for net proceeds of $5.3 million and realized a gain on sale of $2.2 million. This sale was part of management’s plan to transition the HPI Distribution Center operations to the Company’s largest and most technologically advanced semi-robotic worldwide distribution center, located in Eudora, Arkansas.
Interest Expense
Interest expense decreased to $1.2 million for the year ended December 31, 2021 from $2.0 million for the year ended December 31, 2020. This decrease was primarily the result of a decrease in LIBOR rates on our outstanding borrowings and a loss of $0.3 million recognized on our interest rate swap during the year ended December 31, 2020.
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Income Taxes
The effective income tax rate was 11.1% and 20.3% for the years ended December 31, 2021 and 2020, respectively. The decrease in the effective tax rate was primarily driven by decreases of 3.9% for compensation related items, 2.2% for rate impacts due to foreign operations, 1.8% for pension plan terminations and 0.7% for changes in uncertain tax positions. Income tax expense for the year ended December 31, 2021 was favorably impacted by $0.9 million of windfall tax benefits from stock options exercised and $0.6 million of stranded tax benefits recognized as a result of the Company’s termination of its pension plans. For further discussion of changes in the effective tax rate, refer to the Note 7 to the Financial Statements.
Liquidity and Capital Resources
Overview
Management uses a number of standards in measuring the Company’s liquidity, such as: working capital, profitability ratios, cash flows from operating activities, and activity ratios. The Company’s balance sheet generally provides the ability to pursue acquisitions, invest in new product lines and technologies and invest in additional working capital as necessary. As of December 31, 2021, approximately $7.7 million of our cash was held in our foreign subsidiaries, of which $3.7 million of cash was held at foreign subsidiaries from which the Company plans to repatriate the funds as needed for liquidity.
The Company’s primary source of liquidity has been its net income and the use of credit facilities and term loans as described further below. Management currently believes that cash flows provided by operating activities and availability under the revolving credit facility will be sufficient to satisfy the Company’s anticipated working capital requirements and capital expenditures for the next twelve months. Management also currently believes that cash flows provided by operating activities and availability under the revolving credit facility will be sufficient to satisfy the Company’s anticipated working capital requirements and capital expenditures beyond the next twelve months. In the future, the Company may continue to use credit facilities and other secured and unsecured borrowings as a source of liquidity. The Company may also begin relying on the issuance of equity or debt securities, including under its universal shelf registration statement (File No. 333-249760). There can be no assurance that any such financings would be available to us on reasonable terms. Any future issuances of equity securities or securities convertible into or exercisable for equity securities may be dilutive to our shareholders. Additionally, the cost of the Company’s future sources of liquidity may differ from the costs of the Company’s sources of liquidity to date.
Working Capital
Superior’s Uniforms and Related Products segment markets itself to its customers as a “stock house.” Therefore, Superior carries inventories of both raw materials and finished products, the practice of which requires substantial working capital, which we believe to be common in the industry.
Cash and cash equivalents increased by $3.7 million to $8.9 million as of December 31, 2021 from $5.2 million on December 31, 2020. Working capital increased to $188.1 million at December 31, 2021 from $143.6 million at December 31, 2020. The increase in working capital was primarily due to an increase in inventories, an increase in prepaid expenses and other current assets, an increase in accounts receivable and a decrease in other current liabilities, partially offset by an increase in accounts payable. The increase in inventories was primarily driven by the acquisition of Sutter’s Mill in 2021, which included inventory of $9.1 million, and the timing of inventory purchases within our Promotional Products and Uniforms and Related Products segments. The increase in prepaid expenses and other current assets was primarily related to prepaid taxes. The increase in accounts receivable was primarily driven by increased activity and the timing of customer payments received within our Promotional Products segment, partially offset by a decrease from the timing of customer payments received within our Uniforms and Related Products segment. The decrease in other current liabilities was primarily related to significant accruals as of December 31, 2020, associated with the Company’s performance in 2020, that were paid in 2021, including accrued compensation and income taxes. The increase in accounts payable was primarily driven by the timing of inventory purchases within our Promotional Products segment and the acquisition of Sutter’s Mill in 2021.
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Cash Flows
Our cash flows from operating, investing and financing activities, as reflected in the statements of cash flows, are summarized in the following table (in thousands):
| For the Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||||
| Net cash provided by (used in): | ||||||||
| Operating activities | $ | 17,080 | $ | 41,359 | ||||
| Investing activities | (34,130 | ) | (6,573 | ) | ||||
| Financing activities | 20,995 | (38,443 | ) | |||||
| Effect of exchange rates on cash | (182 | ) | (209 | ) | ||||
| Net increase (decrease) in cash and cash equivalents | $ | 3,763 | $ | (3,866 | ) |
Operating Activities. The decrease in net cash provided by operating activities during the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily attributable to payments made in the current year period related to significant accruals as of December 31, 2020 associated with the Company’s performance in 2020, including accrued compensation and income taxes, advanced customer payments received on personal protective equipment contracts in the prior year period and a $4.2 million contingent consideration payment representing the excess of the total contingent consideration payment made in the current year period over the fair value of the liability estimated at the time of acquisition. Working capital cash changes during the year ended December 31, 2021 included an increase of $21.8 million in inventories and an increase of $7.9 million in prepaid expenses and other current assets. Working capital cash changes during the year ended December 31, 2020 included an increase of $32.7 million in accounts payable and other current liabilities, an increase of $29.3 million in accounts receivable and an increase of $16.8 million in inventories.
Investing Activities. The increase in net cash used in investing activities during the year ended December 31, 2021 compared to the year ended December 31, 2020 was attributable to $10.4 million of cash paid for the acquisition of Sutter's Mill in 2021, $6.0 million of cash paid for the acquisition of Gifts by Design in 2021 and an increase in capital expenditures of $5.8 million primarily related to the expansion of our distribution facility in Eudora, Arkansas. Additionally, the year ended December 31, 2020 included $5.3 million in proceeds from the sale of a building and related assets that were previously used as a Distribution Center within our Uniforms and Related Products segment.
Financing Activities. The increase in net cash provided by financing activities during the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily attributable to net borrowings of $27.6 million in debt during 2021 compared to net repayments of $31.7 million of debt in 2020. Excess cash generated from operating activities during the year ended December 31, 2021 was used to fund business acquisitions. Excess cash generated from operating activities during the year ended December 31, 2020 was used to repay outstanding borrowings under the revolving credit facility.
Capital Expenditures
In the foreseeable future, the Company expects to continue its ongoing capital expenditure program designed to improve the effectiveness and capabilities of its facilities and technology. During the year ended December 31, 2021, $8.9 million of our capital expenditures related to the expansion of our distribution facility in Eudora, Arkansas. In 2022, we expect to continue the expansion of our domestic distribution centers and invest in technology improvements, but currently anticipate that we will spend less in capital expenditures in 2022 than we spent in 2021. The Company at all times evaluates its capital expenditure program in light of prevailing economic conditions.
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Credit Facilities (See Note 6 to the Financial Statements)
As of December 31, 2021, the Company had approximately $116.8 million in outstanding borrowings under its credit facilities with Truist Bank, consisting of $61.5 million outstanding under the revolving credit facility, $15.0 million outstanding under a term loan maturing in February 2024 (“2017 Term Loan”) and $40.2 million outstanding under a term loan maturing in January 2026 (“2018 Term Loan”). The revolving credit facility, 2017 Term Loan and 2018 Term Loan are collectively referred to as the “Credit Facilities.”
On February 8, 2021, the Company entered into a Second Amended and Restated Credit Agreement with Truist Bank (the “Credit Agreement”), pursuant to which the maximum availability under the Company’s existing revolving credit facility was increased from $75.0 million to $125.0 million and its maturity date was extended until February 8, 2026. The 2017 Term Loan and the 2018 Term Loan remain outstanding with the same amortization schedules. The floor on LIBOR for the revolving credit facility was increased from zero to 0.25%, but the interest rates on the revolving credit facility and the term loans were not otherwise modified.
Obligations outstanding under the 2018 Term Loan have a variable interest rate of LIBOR plus a margin of between 0.85% and 1.65% (based on the Company’s funded debt to EBITDA ratio) (0.95% at December 31, 2021). Obligations outstanding under the revolving credit facility and the 2017 Term Loan generally have a variable interest rate of one-month LIBOR (with a 0.25% floor on LIBOR for the revolving credit facility) plus a margin of between 0.68% and 1.50% (based on the Company’s funded debt to EBITDA ratio) (0.93% for the revolving credit facility and 0.78% for the 2017 Term Loan at December 31, 2021). The Company is obligated to pay a commitment fee of 0.15% per annum on the average unused portion of the commitment under the revolving credit facility. The available balance under the revolving credit facility is reduced by outstanding letters of credit. At December 31, 2021, the Company had undrawn capacity of $63.5 million under the revolving credit facility.
Contractual principal payments for the 2017 Term Loan are as follows: 2022 through 2023 - $6.0 million per year; and 2024 - $3.0 million. Contractual principal payments for the 2018 Term Loan are as follows: 2022 through 2025 - $9.3 million per year; and 2026 - $3.1 million. The term loans do not contain pre-payment penalties.
The Credit Agreement contains customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, restricted payments, and sales of assets. The Credit Agreement also requires the Company to maintain a fixed charge coverage ratio (as defined in the Credit Agreement) of at least 1.25:1 and a funded debt to EBITDA ratio (as defined in the Credit Agreement) not to exceed 5.0:1. As of December 31, 2021, the Company was in compliance with these ratios. The Credit Facilities are secured by substantially all of the operating assets of the Company as collateral, and the Company’s obligations under the Credit Facilities are guaranteed by all of its domestic subsidiaries. The Company’s obligations under the Credit Facilities are subject to acceleration upon the occurrence of an event of default as defined in the Credit Agreement.
Dividends and Share Repurchase Program
During the years ended December 31, 2021 and 2020, the Company paid cash dividends of $7.2 million and $6.1 million, respectively. The Company anticipates that it will continue to pay dividends in the future as financial conditions permit.
On May 2, 2019, the Company’s Board of Directors approved a stock repurchase program of up to 750,000 shares of the Company’s outstanding common stock. There is no expiration date or other restriction governing the period over which the Company can make share repurchases under the program. All purchases under this program will be open market transactions. Under this program the Company reacquired and retired 43,458 shares of its common stock during the year ended December 31, 2020. At December 31, 2021, the Company’s remaining repurchase capacity under its common stock repurchase program was 657,451 shares. Shares purchased under the common stock repurchase program are constructively retired and returned to unissued status. The Company considers several factors in determining when to make share repurchases, including among other things, the cost of equity, the after-tax cost of borrowing, the debt to total capitalization targets and its expected future cash needs.
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Contractual Obligations
The following table sets forth a summary of our material contractual obligations as of December 31, 2021 (in thousands):
| Payments Due by Period | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2023-2024 | 2025-2026 | Thereafter | ||||||||||||
| Debt: | |||||||||||||||
| Revolving credit facility(1) | $ | - | $ | - | $ | 61,517 | $ | - | |||||||
| Term Loans(1) | 15,286 | 27,572 | 12,380 | - | |||||||||||
| Operating leases | 2,153 | 2,958 | 1,283 | - | |||||||||||
| Acquisition-related contingent liabilities(2) | 4,762 | 3,000 | 1,500 | - | |||||||||||
| Total long term contractual cash obligations(3) | $ | 22,201 | $ | 33,530 | $ | 76,680 | $ | - |
| (1) | Excludes estimates for interest payable as amounts are based on variable rates. See Note 6 to the Financial Statements. |
|---|---|
| (2) | The amounts represent the expected cash payment. The amounts in our balance sheet are stated at fair value. |
| (3) | Certain long-term liabilities have been excluded from this table as we cannot make a reasonable estimate of the period of cash settlement. These long-term liabilities include unrecognized tax benefits of $0.9 million, net defined benefit plan liability of $15.1 million and deferred compensation liability of $7.8 million. |
Critical Accounting Estimates
Our significant accounting policies are described in Note 1 to the Financial Statements included in this Form 10-K. Our discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. 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.
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. 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
Judgments and estimates are used in determining the collectability of accounts receivable and in establishing allowances for doubtful accounts. The Company analyzes specific trade accounts receivable and historical bad debt experience, customer credit worthiness, current economic trends and the age of outstanding balances when evaluating the adequacy of the allowance for doubtful accounts. Management judgments and estimates are used in connection with establishing the allowance in any accounting period. Changes in estimates are reflected in the period they become known. 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 5% of accounts receivable would require an increase in the allowance for doubtful accounts and would result in additional expense of approximately $5.4 million. During the years ended December 31, 2021, 2020 and 2019, we recorded bad debt expense of $2.3 million, $6.7 million and $1.3 million, respectively. The Company’s concentration of risk is also monitored and as of December 31, 2021, the five largest customer accounts receivables balances totaled $29.6 million or approximately 28% of the respective total accounts receivable balances.
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Revenue Recognition
Revenue is measured at the amount of consideration we expect to receive in exchange for the goods or services. Variable consideration for estimated returns, allowances and other price variances is recorded based upon historical experience and current allowance programs. Contract termination terms may involve variable consideration clauses such as sales discounts and customer rebates, and revenue is adjusted accordingly for these provisions. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.
Inventories
The Company’s Uniforms and Related Products segment markets itself to its customers as a “stock house.” Therefore, the Company at all times carries inventories of both raw materials and finished products. Inventories are stated at the lower of cost or net realizable value. Judgments and estimates are used in determining the likelihood that 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, which may be material.
Goodwill and indefinite-lived intangible assets
The Company has made acquisitions in the past that included goodwill and indefinite-lived intangible assets. Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill and indefinite-lived intangible assets such as trade names are not amortized but are subject to an annual (or under certain circumstances more frequent) impairment test in the fourth quarter based on their estimated fair value. We test more frequently, if there are indicators of impairment, or whenever such circumstances suggest that the carrying value of goodwill or trade names may not be recoverable. 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; and |
| • | other relevant entity-specific events such as changes in management, key personnel, strategy, or customers. |
Goodwill and indefinite-lived intangible assets are tested at a level of reporting referred to as “the reporting unit.” The Company’s reporting units are defined as each of its three reporting segments. As of December 31, 2021, goodwill of $24.4 million and $15.0 million were included in the Uniforms and Related Products segment and the Promotional Products segment, respectively. As of December 31, 2021, indefinite-lived intangible assets of $18.8 million and $14.5 million were included in the Uniforms and Related Products segment and the Promotional Products segment, respectively.
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 impairment test is unnecessary. For each of the years ended December 31, 2021, 2020 and 2019, the Company completed its testing of goodwill and indefinite-lived intangible assets and determined that the fair value of each applicable reporting unit was more than its carrying value.
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Contingent Consideration
The purchase price to acquire substantially all of the assets of Sutter’s Mill in 2021 included contingent consideration based on varying levels of Sutter’s Mill’s EBITDA in each measurement period from 2022 to 2024. The estimated fair value for Sutter’s Mill acquisition-related contingent consideration payable as of December 31, 2021 was $2.6 million. The total estimated undiscounted remaining payment related to this contingent consideration payable is between $2.4 million and $4.7 million. The Company’s fair value estimate of contingent consideration is primarily derived from management’s forecasted EBITDA of Sutter’s Mill. The Company will continue to evaluate this liability for remeasurement at the end of each reporting period and any changes will be recorded in the Company’s statements of comprehensive income. The carrying amount of the liability may fluctuate significantly and actual amounts paid may be materially different from the estimated value of the liability.
Insurance
The Company self-insures for certain obligations related to employee health 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.
SERP
The Company is the sponsor of an unfunded supplemental executive retirement plan (“SERP”) in which several of its employees are participants. In calculating our obligations and related expense, we make various assumptions and estimates, after consulting with outside actuaries and advisors. The annual determination of expense involves calculating the estimated total benefits ultimately payable to plan participants. Significant assumptions related to the calculation of our obligations include the discount rates used to calculate the present value of benefit obligations to be paid in the future. We review these assumptions annually based upon currently available information, including information provided by our actuaries. The Company’s pension obligations are determined using estimates including those related to discount rates. The discount rates used for the Company’s SERP of 2.36% was determined based on the FTSE Russell Pension Liability 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. For additional information on our benefit plans, please refer to Note 8 to the Financial Statements.
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Income Taxes
The Company is required to estimate and record income taxes payable for federal, state and foreign jurisdictions in which the Company operates. This process involves estimating actual current tax expense and assessing temporary differences resulting from differing accounting treatment between tax and book that result in deferred tax assets and liabilities. In addition, accruals are also estimated for federal and state tax matters for which deductibility is subject to interpretation. Taxes payable and the related deferred tax differences may be impacted by changes to tax laws, changes in tax rates and changes in taxable profits and losses. The Tax Cuts and Jobs Act (“Tax Act”) enacted on December 22, 2017 imposes a U.S. tax on global intangible low taxed income (“GILTI”) that is earned by certain foreign affiliates owned by a U.S. shareholder. GILTI is generally intended to impose tax on the earnings of a foreign corporation that are deemed to exceed a certain threshold return relative to the underlying business investment. In accordance with guidance issued by FASB, the Company made a policy election to treat future taxes related to GILTI as a current period expense in the reporting period in which the tax is incurred. The Company was impacted by GILTI relative to the earnings of its foreign subsidiaries, and is expected to be impacted in future periods, which may be material to our financial statements. Deferred income taxes are provided on undistributed earnings of foreign subsidiaries in the period in which the Company determines it no longer intends to permanently reinvest such earnings outside the United States. The Company expects to permanently reinvest the earnings from its wholly-owned Brazilian and UK subsidiaries, and accordingly, has not provided deferred taxes on the subsidiaries’ undistributed net earnings or basis differences. The Company believes that the tax liability that would be incurred upon repatriation of the earnings from its Brazilian and UK subsidiaries is immaterial at December 31, 2021.
Reserves are also estimated for uncertain tax positions that are currently unresolved. The Company routinely monitors the potential impact of such situations and believes that it is properly reserved. For the year ended December 31, 2021, there was a decrease of $0.3 million in total unrecognized tax benefits. As of December 31, 2021, we had an accrued liability of $0.9 million for unrecognized tax benefits. We accrue interest and penalties related to unrecognized tax benefits in income tax expense, and the related liability is included in other long-term liabilities in our balance sheet.
Share-Based Compensation
The Company recognizes expense for all share-based payments to employees, including grants of employee stock options, in the financial statements based on their fair values. In the Company’s share-based compensation strategy we utilize a combination of stock options and stock-settled stock appreciation rights (“SARs”) that vest over time and restricted shares and performance shares of common stock that vest over time or if performance targets are met. The fair value of the options and SARs granted is recognized as expense on the date of grant or over the service period. The Company uses the Black-Scholes valuation model to value any share-based compensation. Option valuation methods, including Black-Scholes, require the input of highly complex and subjective assumptions including the risk free interest rate, dividend rate, expected term and common stock price volatility rate. The Company determines the assumptions to be used based upon current economic conditions. While different assumptions may result in materially different stock compensation expenses, changing any one of the individual assumptions by 10% would not have a material impact on the recorded expense. Expense for unvested shares of restricted stock and performance shares is recognized over the required service period. For additional information on share-based compensation and the assumptions we use, please refer to Note 11 to the Financial Statements.
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