SUPERIOR GROUP OF COMPANIES, INC. (SGC) FY 2022 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, 2022 and 2021, as well as our financial positions at December 31, 2022 and 2021, 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. Additionally, we use a non-GAAP financial measure to evaluate our results of operations. For important information regarding the use of such non-GAAP financial measure, including reconciliations to the most comparable GAAP measure, see the section titled “Non-GAAP Financial Measure” below.
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.
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) $10.5 million in cash, (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.
On May 1, 2022, the Company, through BAMKO, acquired substantially all of the assets of Guardian Products, Inc. (“Guardian”) of Norcross, Georgia. Guardian is a branded merchandise company that is one of the leading providers of promotional products to automotive dealers nationwide. The purchase price for the acquisition consisted of the following: (a) $11.1 million in cash, subject to a working capital adjustment, (b) the issuance of 116,550 restricted shares of Superior’s common stock (the “Guardian Stock”) that vest ratably over a three-year period, and (c) estimated potential future payments of approximately $2.3 million in additional contingent consideration based on the results of the acquired business through April 2025. The Guardian Stock is subject to transfer restrictions over the three-year period following the closing of the acquisition.
Business Outlook
Superior is comprised of three reportable business segments: (1) Branded Products, (2) Healthcare Apparel and (3) Contact Centers. Beginning in the second quarter of 2022, the Company realigned its reportable segments to correspond with changes to its organizational responsibilities, management structure and operating model. Prior to implementing the current segment reporting, the Company’s Uniforms and Related Products segment included both healthcare apparel and uniforms. As part of the change in reportable segments, the branded portion of the uniforms business was combined with the previous Promotional Products segment to form the Branded Products segment, the healthcare apparel business became its own segment named Healthcare Apparel and income and expenses related to corporate functions that are not specifically attributable to an individual reportable segment are no longer presented in segment results. The previous Remote Staffing Solutions segment was renamed Contact Centers segment. All prior period segment information has been recast to reflect this change in reportable segments.
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Branded Products
In our Branded Products segment, we produce and sell customized merchandising solutions, promotional products and branded uniform programs to our customers. As a strategic branding partner, we offer our customers customized branding solutions and strategies that generate favorable brand impressions, bolster customer retention and enhance employee engagement. Our products are sold to customers in a wide range of industries, including retail, hotel, food service, entertainment, technology, transportation and other industries. Sales volumes in this segment are impacted by a number of factors, including marketing programs of our customers and turnover of our customers’ employees, often times driven by the opening and closing of locations. The COVID-19 pandemic reduced demand for our products in many of our customers’ industries, such as the restaurant, transportation, hospitality and entertainment industries, which was more than offset by demand from customers in the delivery service industry and certain retail industries, such as grocery and pharmacy. The COVID-19 pandemic initially also created significant opportunities for us within the personal protective equipment market; while we continue to source some personal protective equipment for our customers, we anticipate that demand for personal protective equipment will continue to decline. From a long-term perspective, we believe that synergies within this segment will create opportunities to cross-sell products to new and existing customers.
Healthcare Apparel
In our Healthcare Apparel segment, we manufacture (through third parties or in our own facilities) and sell a wide range of healthcare apparel, such as scrubs, lab coats, protective apparel and patient gowns. We sell our brands of healthcare service apparel to healthcare laundries, dealers, distributors and retailers primarily in the United States. In 2021, the COVID-19 pandemic created increased demand for healthcare service apparel from laundries, dealers and distributors that service hospitals and other medical facilities. As a result, the healthcare apparel market has been oversupplied creating a slowdown in demand in 2022. Additionally, the market demand for personal protective equipment has declined as a result of the progression of the COVID-19 pandemic. 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.
Contact Centers
This business segment (also known as “The Office Gurus”), which operates in El Salvador, Belize, Jamaica, Dominican Republic, and the United States, provides outsourced, nearshore business process outsourcing, contact and call-center support services to North American customers. These services are also provided internally to the Company’s other two operating segments. The Office Gurus has become an award-winning business process outsourcer offering inbound and outbound voice, email, text, chat and social media support. The nearshore call-center market has grown as businesses look to reduce operating costs while maintaining high-quality customer support. Nearshore operators are able to provide comparable service to their U.S. counterparts at a fraction of the price. COVID-19 has acted as a catalyst for rapid transformation within the traditional business process outsourcing model. 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.
Global Economic and Political Conditions
Economic and political events in the past twelve months have altered the landscape in which we and other U.S. companies operate in a variety of ways. In response to inflationary pressures, the U.S. Federal Reserve repeatedly has raised interest rates, resulting in an increase in the cost of borrowing for us, our customers, our suppliers, and other companies relying on debt financing. It has indicated that it likely will raise rates further. World events, such as the Russian invasion of Ukraine and the resulting economic sanctions, have impacted the global economy, including by exacerbating inflationary and other pressures. Prolonged inflationary conditions, high and/or increased interest rates, and additional sanctions or retaliatory measures related to the Russia-Ukraine crisis, or other situations, including deteriorating or prolonged diplomatic tension between the United States and China, could further negatively affect U.S. and international commerce and exacerbate or prolong the period of high energy prices. At this time, the extent and duration of these economic and political events and their effects on the economy and the Company are impossible to predict.
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 indefinite-lived intangible assets.
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COVID-19 Impact
The COVID-19 pandemic continues to affect our operations around the world and financial performance, although to a lesser extent than in the previous two years. Nonetheless, the cumulative impact of the COVID-19 pandemic on our business, financial condition, results of operations and cash flows continues to depend on numerous factors that are difficult to predict. Prolonged or recurring periods of difficult market conditions could have material adverse impacts on our business, financial condition, results of operations and cash flows.
In responding to the needs of our customers, we sourced personal protective equipment, including face masks, isolation gowns, sanitizers, gloves and COVID-19 testing kits, which contributed $6.6 million and $2.8 million to net sales during the year ended December 31, 2022 for our Branded Products segment and Healthcare Apparel segment, respectively. Personal protective equipment net sales for our Branded Products segment and Healthcare Apparel segment were $30.6 million and $8.0 million, respectively, during the year ended December 31, 2021.
Sourcing of Goods and Raw Materials
Along with many manufacturers that source goods and raw materials from abroad, we experienced significant supply disruptions and delays due to a variety of reasons. These changes were 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 had the effect of increasing demand for shipping capacity from Asia, leading to capacity constraints. Both factors increased shipping times as well as the price of shipping, whether by sea, air, rail, or vehicle.
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. Principal fabrics used in the manufacture of the Company’s finished goods include cotton, polyester, cotton-synthetic, poly-synthetic blends, textiles, plastic, glass, fabric and metal. The majority of such fabrics are sourced in China, either directly by us or our 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.
Summary of Results
Net Income (loss)
The Company generated a net loss of $32.0 million during the year ended December 31, 2022 and net income of $29.4 million during the year ended December 31, 2021. The decrease in net income during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to goodwill and indefinite-lived intangible assets impairment charges totaling $51.5 million in 2022, an increase in inventory write-downs of $10.8 million, a decrease in Healthcare Apparel net sales and an increase in selling and administrative expenses, partially offset by an increase in Branded Products and Contact Centers net sales, a decrease in income tax expense and a pension plan termination charge recorded in 2021.
Adjusted EBITDA
Adjusted EBITDA (a non-GAAP financial measure) was $27.9 million and $51.5 million during the years ended December 31, 2022 and 2021, respectively. Adjusted EBITDA during the year ended December 31, 2022 compared to the year ended December 31, 2021 decreased primarily due to an increase in inventory write-downs, a decrease in Healthcare Apparel net sales and an increase in selling and administrative expenses, partially offset by an increase in Branded Products and Contact Centers net sales. For a reconciliation of Adjusted EBITDA to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP, please read “Non-GAAP Financial Measure” below.
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The Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021
Operations
Net Sales (in thousands, except percentages):
| For the Years Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | % Change | ||||||||||
| Branded Products | $ | 387,931 | $ | 340,487 | 13.9 | % | ||||||
| Healthcare Apparel | 113,321 | 139,288 | (18.6 | %) | ||||||||
| Contact Centers | 84,218 | 64,312 | 31.0 | % | ||||||||
| Net Intersegment Eliminations | (6,639 | ) | (7,101 | ) | (6.5 | %) | ||||||
| Consolidated Net Sales | $ | 578,831 | $ | 536,986 | 7.8 | % |
Net sales for the Company increased 7.8% from $537.0 million for the year ended December 31, 2021 to $578.8 million for the year ended December 31, 2022. The principal components of this aggregate increase in net sales were as follows: (1) an increase in net sales for our Branded Products segment (contributing 8.8%), (2) a decrease in net sales for our Healthcare Apparel segment (contributing (4.8%)), and (3) an increase in net sales for our Contact Centers segment after intersegment eliminations (contributing 3.8%).
Branded Products net sales increased 13.9%, or $47.4 million, for the year ended December 31, 2022 compared to the year ended December 31, 2021. The increase was primarily due to net sales of $44.2 million attributable to the acquisitions of Sutter’s Mill in December 2021 and Guardian in May 2022 and organic growth through new customers and the expansion of existing customers. These increases were partially offset by a decrease of $24.0 million in net sales of personal protective equipment driven by the progression of the COVID-19 pandemic.
Healthcare Apparel net sales decreased 18.6%, or $26.0 million, for the year ended December 31, 2022 compared to the year ended December 31, 2021. The decrease was primarily due to a decrease in demand for healthcare apparel resulting from market conditions in 2022, most notably, a market saturated with inventory as the COVID-19 pandemic progressed. Additionally, net sales of personal protective equipment decreased by $5.2 million. The sale of personal protective equipment during the year ended December 31, 2021 was driven by market demand as a result of the progression of the COVID-19 pandemic.
Contact Centers net sales increased 31.0% before intersegment eliminations and 35.6% after intersegment eliminations for the year ended December 31, 2022 compared to the year ended December 31, 2021. These increases were primarily attributed to providing expanded services to our existing customers and the onboarding of new customers in 2022.
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 Branded Products and Healthcare Apparel segments. Cost of goods sold for our Contact Centers 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. The cost of occupancy and operating the Company’s distribution centers are included in selling and administrative expenses.
As a percentage of net sales, total cost of goods sold was 66.6% for the year ended December 31, 2022 and 65.4% for the year ended December 31, 2021. The percentage increase was primarily due to an increase in inventory write-downs of $10.8 million, most of which related to excess and obsolete inventory on discontinued styles and personal protective equipment within our Healthcare Apparel segment.
As a percentage of net sales, cost of goods sold for our Branded Products segment was 70.4% for the year ended December 31, 2022 and 70.6% for the year ended December 31, 2021. As a percentage of net sales, cost of goods sold remained relatively flat.
As a percentage of net sales, cost of goods sold for our Healthcare Apparel segment was 71.2% for the year ended December 31, 2022 and 62.6% for the year ended December 31, 2021. The percentage increase was primarily due to $11.4 million in inventory write-downs in 2022 of excess and obsolete inventory related to discontinued styles and personal protective equipment. The inventory write-downs were primarily driven by current market conditions resulting in decreased demand for healthcare apparel, most notably, a market saturated with inventory as the COVID-19 pandemic progressed.
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As a percentage of net sales, cost of goods sold for our Contact Centers segment was 40.9% for the year ended December 31, 2022 and 41.5% for the year ended December 31, 2021. As a percentage of net sales, cost of goods sold remained relatively flat.
Selling and Administrative Expenses
As a percentage of net sales, total selling and administrative expenses was 30.5% for the year ended December 31, 2022 and 26.5% for the year ended December 31, 2021. The increase was primarily due to expense deleverage resulting from the 18.6% decrease in Healthcare Apparel net sales, an increase in employee costs, which was mostly driven by an increase in headcount to support growth in our Branded Products and Contact Centers segments and an increase in depreciation and amortization expense. These increases were partially offset by an unrealized gain of $1.6 million recognized during 2022 driven by a decrease in the fair value of written put options. For more information on the written put options, please refer to the disclosure in Note 1 to the Financial Statements, which is incorporated herein by reference.
As a percentage of net sales, selling and administrative expenses for our Branded Products segment was 23.2% for the year ended December 31, 2022 and 20.6% for the year ended December 31, 2021. The percentage increase was primarily attributed to increased investment to support future growth of this segment, including the expansion of our workforce, and a decrease in personal protective equipment net sales, which have disproportionately lower selling and administrative expenses associated with them.
As a percentage of net sales, selling and administrative expenses for our Healthcare Apparel segment was 34.7% for the year ended December 31, 2022 and 25.7% for the year ended December 31, 2021. The percentage increase was primarily attributed to the decrease in sales explained above and an increase in selling and administrative expenses resulting from increased employee related costs, customer support costs, travel expenses and advertising activities. The decrease in sales included a decrease in personal protective equipment net sales, which have disproportionately lower selling and administrative expenses associated with them.
As a percentage of net sales, selling and administrative expenses for our Contact Centers segment was 39.9% for the year ended December 31, 2022 and 36.9% for the year ended December 31, 2021. The percentage increase was primarily attributed to increased investment in organizational infrastructure, including facilities and personnel, to support future growth of this segment.
Goodwill Impairment Charge
In conjunction with the re-segmentation during the second quarter of 2022, the Company performed a goodwill impairment analysis and determined that the estimated fair value of the previous Uniforms and Related Products segment was lower than its carrying value primarily as the result of current market conditions, decline in expected cash flows and decrease in the Company’s stock price. During the third quarter of 2022, the Company determined that a triggering event occurred in relation to the depressed market price of the Company’s common stock and corresponding significant decline in the Company’s market capitalization. As a result, the Company performed a goodwill impairment analysis and determined that the estimated fair value of the Branded Products segment was lower than its carrying value. Consequently, the Company recorded a non-cash goodwill impairment charge of $45.9 million during the year ended December 31, 2022. This charge was non-cash in nature and does not affect our liquidity or debt covenants.
Intangible Assets Impairment Charge
In conjunction with the Company’s realignment of its reportable segments during the second quarter of 2022, the Company began an effort to centralize certain branding and go-to-market strategies under the BAMKO brand and determined that it would no longer use certain trade names associated with branded products. The Company’s rebranding efforts resulted in a $5.6 million impairment of indefinite-lived trade names related to its Branded Products segment during the year ended December 31, 2022. This charge was non-cash in nature and does not affect our liquidity or debt covenants.
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 to plan participants. The pension plan terminations did not require a cash outlay by the Company.
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Gain on Sale of Property, Plant and Equipment
During the year ended December 31, 2022, the Company sold its corporate headquarters building and related assets for net proceeds of $4.8 million and realized a gain on sale of $3.4 million. This sale was part of management’s plan to relocate the Company’s corporate headquarters to St. Petersburg, Florida.
Interest Expense
Interest expense increased to $4.9 million for the year ended December 31, 2022 from $1.2 million for the year ended December 31, 2021. This increase was primarily due to an increase in interest rates on our outstanding borrowings, $0.5 million of expense relating to the write-off of unamortized debt issuance costs associated with our former senior secured credit facility and an increase in outstanding borrowings. The weighted average interest rate on our outstanding borrowings for the year ended December 31, 2022 was 2.4% compared to 0.9% for the year ended December 31, 2021.
Income Taxes
The effective income tax rate was 15.9% and 11.1% for the years ended December 31, 2022 and 2021, respectively. Income tax expense for the year ended December 31, 2022 was impacted by a tax benefit of $7.0 million relating to the impairment of intangible assets and a portion of the goodwill impairment. The effective tax rate for the year ended December 31, 2022 was impacted by the nondeductible portion of the goodwill impairment charge totaling $21.1 million. Income tax expense for the year ended December 31, 2021 was favorably impacted by a reversal of $1.8 million in deferred tax liabilities associated with the termination of the Company’s two qualified defined benefit pension plans, $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 Note 9 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, 2022, approximately $11.3 million of our cash was held in our foreign subsidiaries, of which $7.9 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. The cost of borrowing has increased in 2022, with the interest rate of outstanding borrowings under the revolving credit facility of 6.2% at December 31, 2022 compared to 0.9% at December 31, 2021 under the previous revolving credit facility.
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 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.
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Cash and cash equivalents increased by $8.8 million to $17.7 million as of December 31, 2022 from $8.9 million on December 31, 2021. Working capital increased to $232.8 million at December 31, 2022 from $188.1 million at December 31, 2021. The increase in working capital was primarily due to increases in contract assets and cash and cash equivalents and decreases in the current portion of long-term debt and accounts payable. The increase in contract assets was primarily related to the timing of shipments to customers and receipts from suppliers for finished goods with no alternative use within our Branded Products segment. The increase in cash and cash equivalents was primarily related to the timing of payments on outstanding borrowings and proceeds from the sale of the Company’s corporate headquarters building and related assets in 2022. The decrease in the current portion of long-term debt was the result of contractual obligations under the new credit agreement, which was entered into on August 23, 2022. The decrease in accounts payable was primarily driven by the timing of payments for inventory purchases within our Branded Products segment.
Material Short-Term Plans for Cash
For the next twelve months, our primary capital requirements is for capital to maintain our operations, meet the contractual obligations shown in the column titled “2023” in the contractual obligations table below, and to fund capital expenditures, dividends and other general corporate purposes. We currently anticipate that we will spend less in capital expenditures in 2023 than we spent in 2022. Management currently believes that the combination of our current cash level, cash flows provided by operating activities and availability under the revolving credit facility, subject to a potential amendment as described in Note 8 to the Financial Statements, will be sufficient to satisfy the above requirements for the next twelve months.
Material Long-Term Plans for Cash
Beyond the next twelve months, our principal demand for funds will be for maintenance of our core business, to satisfy the requirements shown in the columns “2024-2025” and “2026-2027” in the contractual obligations table below, as well as the obligations described in footnote (3) to the table, and the continuation of the Company’s ongoing capital expenditure program designed to improve the effectiveness and capabilities of its facilities and technology. The Company at all times evaluates its capital expenditure program in light of prevailing economic conditions. Management currently believes that the combination of our current cash level, cash flows provided by operating activities and availability under the revolving credit facility, subject to a potential amendment as described in Note 8 to the Financial Statements, will be sufficient to satisfy the above requirements.
Contractual Obligations
The following table sets forth a summary of our material contractual obligations as of December 31, 2022 (in thousands):
| Payments Due by Period | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2024-2025 | 2026-2027 | Thereafter | ||||||||||||
| Debt: | |||||||||||||||
| Revolving credit facility(1) | $ | - | $ | - | $ | 83,000 | $ | - | |||||||
| Term Loan(1) | 3,750 | 10,313 | 59,062 | - | |||||||||||
| Operating leases | 3,207 | 3,569 | 1,080 | - | |||||||||||
| Acquisition-related contingent liabilities(2) | 835 | 4,126 | - | - | |||||||||||
| Total long term contractual cash obligations(3) | $ | 7,792 | $ | 18,008 | $ | 143,142 | $ | - |
| (1) | Excludes estimates for interest payable as amounts are based on variable rates. See Note 8 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 $0.8 million, unfunded obligations related to the SERP of $13.0 million and deferred compensation liability of $7.7 million. |
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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, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||
| Net cash provided by (used in): | ||||||||
| Operating activities | $ | (2,604 | ) | $ | 17,080 | |||
| Investing activities | (17,425 | ) | (34,130 | ) | ||||
| Financing activities | 28,846 | 20,995 | ||||||
| Effect of exchange rates on cash | (30 | ) | (182 | ) | ||||
| Net increase in cash and cash equivalents | $ | 8,787 | $ | 3,763 |
Operating Activities. The decrease in net cash provided by operating activities during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily attributable to increases in cash outflows for selling and administrative expenses, contract assets and accounts payable, partially offset by an increase in gross margin and a decrease in cash outflows for inventory. Working capital cash changes during the year ended December 31, 2022 included a decrease of $14.6 million in accounts payable and other current liabilities, an increase of $15.9 million in inventory and an increase of $15.1 million in contract assets. Working capital cash changes during the year ended December 31, 2021 included an increase of $24.5 million in inventories.
Investing Activities. The decrease in net cash used in investing activities during the year ended December 31, 2022 compared to the year ended December 31, 2021 was attributable to a decrease in capital expenditures of $6.7 million primarily related to the expansion of our distribution facility in Eudora, Arkansas in the previous year and a decrease in cash paid for acquisitions, which included the acquisitions of Guardian in 2022, Sutter's Mill in 2021 and Gifts by Design in 2021. Additionally, the year ended December 31, 2022 included $4.8 million in net proceeds from the sale of the Company’s corporate headquarters building and related assets.
Financing Activities. The increase in net cash provided by financing activities during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily attributable to an increase in net borrowings of $11.8 million in debt, partially offset by a decrease of $2.0 million in proceeds received on exercise of stock options and an increase in dividend payments of $1.4 million.
Credit Facilities (See Note 8 to the Financial Statements)
On August 23, 2022, the Company entered into a Credit Agreement (the “Credit Agreement”) among the Company, the domestic subsidiaries of the Company, as guarantors, the lenders party thereto (the “Lenders”), and PNC Bank, National Association, as administrative agent for the Lenders (the “Administrative Agent”), pursuant to which the Lenders are providing the Company senior secured credit facilities maturing in August 2027 consisting of a revolving credit facility in the aggregate maximum principal amount of $125.0 million and a term loan in the original aggregate principal amount of $75.0 million (collectively, the “Credit Facilities”), and the ability to request incremental revolving credit or term loan facilities in an aggregate amount of up to an additional $75.0 million, subject to obtaining additional lender commitments and satisfying certain other conditions.
As of December 31, 2022, the Company had $156.1 million in outstanding borrowings under its Credit Facilities, consisting of $83.0 million outstanding under the revolving credit facility and $73.1 million outstanding under a term loan.
Obligations outstanding under the Credit Facilities accrue interest at a variable rate equal to the secured overnight financing rate (“SOFR”) plus an adjustment of between 0.10% and 0.25% (depending on the applicable interest period) plus a margin of between 1.0% and 2.0% (depending on the Company’s net leverage ratio). The interest rate on outstanding borrowings under the Credit Facilities was 6.2% at December 31, 2022. During the term of the revolving credit facility, the Company will pay a commitment fee on the unused portion of the revolving credit facility equal to between 0.125% and 0.250% (depending on the Company’s net leverage ratio). The available balance under the revolving credit facility is reduced by outstanding letters of credit. As of December 31, 2022, the Company had undrawn capacity of $42.0 million under the revolving credit facility.
Contractual principal payments for the term loan are as follows: 2023 - $3.7 million; 2024 - $4.7 million; 2025 - $5.6 million; 2026 - $6.6 million; and 2027 - $52.5 million. The term loan does not contain pre-payment penalties.
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The Credit Facilities are secured by substantially all of the operating assets of the Company, 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. 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 (including dividends and related distributions), liquidations, mergers, consolidations or acquisitions, affiliate transactions and sales of assets or subsidiaries. The Credit Agreement also requires the Company to comply with a fixed charge coverage ratio of at least 1.25 to 1.0 and a net leverage ratio not to exceed 4.0 to 1.0. The Company’s net leverage ratio (as defined in the Credit Agreement) is generally calculated as the ratio of (a) indebtedness minus unrestricted cash to (b) consolidated EBITDA for the four most recently ended fiscal quarters. As of December 31, 2022, the Company was in compliance with these ratios as the Company’s fixed charge coverage and net leverage ratios were 1.73 to 1.0 and 3.85 to 1.0, respectively. Based on the Company’s forecast, it is more likely than not that the Company will exceed the net leverage ratio covenant during 2023. As a result, the Company has initiated good faith discussions with the lending agent on ways to address a potential amendment process, should an amendment be needed in order to maintain compliance throughout the year. Any such amendment or waiver would be subject to the applicable provisions of the Credit Agreement, including the approval of lenders constituting Required Lenders as defined under the Credit Agreement.
Dividends and Share Repurchase Program
During the years ended December 31, 2022 and 2021, the Company paid cash dividends of $8.7 million and $7.2 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. The Company did not reacquire and retire shares of its common stock under this program during the years ended December 31, 2022 and 2021. At December 31, 2022, 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.
Non-GAAP Financial Measure
Adjusted EBITDA, which is a non-GAAP financial measure, is defined as net income (loss) excluding interest expense, income tax expense, depreciation and amortization expense, impairment charges and the other items described in the following sentence. The Company believes Adjusted EBITDA is an important measure of operating performance because it allows management, investors and others to evaluate and compare the Company’s core operating results from period to period by (i) removing the impact of the Company’s capital structure (interest expense from outstanding debt), (ii) tax consequences, (iii) asset base (depreciation and amortization), (iv) the non-cash charges from the termination of the Company’s pension plans and the goodwill and intangible asset impairments and (v) gains or losses on sale of property, plant and equipment. The Company uses Adjusted EBITDA internally to monitor operating results and to evaluate the performance of its business. In addition, the compensation committee has used Adjusted EBITDA in evaluating certain components of executive compensation, including performance-based annual incentive programs.
Adjusted EBITDA is not a measure of financial performance under GAAP and should not be considered in isolation or as an alternative to net income (loss), cash flows from operating activities or any other measure determined in accordance with GAAP. The items excluded to calculate Adjusted EBITDA are significant components in understanding and assessing the Company’s results of operations. The presentation of the Company’s Adjusted EBITDA may change from time to time, including as a result of changed business conditions, new accounting pronouncements or otherwise. If the presentation changes, the Company undertakes to disclose any change between periods and the reasons underlying that change. The Company’s Adjusted EBITDA may not be comparable to a similarly titled measure of another company because other entities may not calculate Adjusted EBITDA in the same manner.
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The following table reconciles net income (loss) to Adjusted EBITDA (in thousands):
| Years Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||
| Net income (loss) | $ | (31,970 | ) | $ | 29,440 | ||
| Interest expense | 4,894 | 1,220 | |||||
| Income tax expense (benefit) | (6,065 | ) | 3,687 | ||||
| Depreciation and amortization | 13,004 | 9,291 | |||||
| Goodwill impairment charge | 45,918 | - | |||||
| Intangible assets impairment charge | 5,581 | - | |||||
| Pension plan termination charge | - | 7,821 | |||||
| Gain on sale of property, plant and equipment | (3,435 | ) | - | ||||
| Adjusted EBITDA | $ | 27,927 | $ | 51,459 |
Critical Accounting Policies and Estimates
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. Our accounting policies are more fully described in Note 1 to the Financial Statements included in this Form 10-K. 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. We believe that the following critical accounting policies and estimates have a higher degree of inherent uncertainty and require our most significant judgments.
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 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, current revenue trends and market conditions are considered in estimating both excess and obsolete inventories. During the year ended December 31, 2022, the Company recognized a $13.6 million charge to cost of goods sold to write-down inventory to its net realizable value, of which $11.4 million related to our Healthcare Apparel segment and $2.2 million related to our Branded Products segment. The inventory write-downs in our Healthcare Apparel segment were related to excess and obsolete inventory associated with discontinued styles and personal protective equipment, which were primarily driven by current market conditions resulting in decreased demand for healthcare apparel, most notably, a market saturated with inventory as the COVID-19 pandemic progressed. The inventory write-downs in our Branded Products segment were related to excess inventory associated with personal protective equipment. 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. An additional write-down in value of 5% of inventories would result in additional expense of approximately $6.0 million.
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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. |
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. 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.
For the year ended December 31, 2021, 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.
In conjunction with the re-segmentation during the second quarter of 2022, the Company performed a goodwill impairment analysis and determined that the estimated fair value of the previous Uniforms and Related Products segment was lower than its carrying value primarily as the result of current market conditions, decline in expected cash flows and decrease in the Company’s stock price. During the third quarter of 2022, the Company determined that a triggering event occurred in relation to the depressed market price of the Company's common stock and corresponding significant decline in the Company’s market capitalization. As a result, the Company performed a goodwill impairment analysis and determined that the estimated fair value of the Branded Products segment was lower than its carrying value. Consequently, the Company recorded a non-cash goodwill impairment charge of $45.9 million during the year ended December 31, 2022. As of December 31, 2022, the Company had no remaining goodwill balance. The fair value of goodwill in each impairment test was determined using a combination of an income approach, which estimates fair value based upon projections of future revenues, expenses, and cash flows discounted to their respective present values, and a market approach. The valuation methodology and underlying financial information included in the Company’s determination of fair value required significant judgments by management. The principal assumptions used in the Company’s discounted cash flow analysis consisted of (a) long-term projections of financial performance and (b) the weighted-average cost of capital of market participants, adjusted for the risk attributable to the Company and the industry in which it operates. Under the market approach, the principal assumption included an estimate of a control premium.
In conjunction with the Company’s realignment of its reportable segments during the second quarter of 2022, the Company began an effort to centralize certain branding and go-to-market strategies under the BAMKO brand and determined that it would no longer use certain trade names associated with branded products. The Company’s rebranding efforts resulted in a $5.6 million impairment of indefinite-lived trade names related to its Branded Products segment during the year ended December 31, 2022. As of December 31, 2022, indefinite-lived intangible assets of $13.6 million and $14.2 million were included in the Branded Products segment and the Healthcare Apparel segment, respectively.
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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, 2022.
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, 2022, there was a decrease of $0.1 million in total unrecognized tax benefits. As of December 31, 2022, we had an accrued liability of $0.8 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.