SUPERIOR GROUP OF COMPANIES, INC. - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the transition period from ________ to __________

Commission file number: 001-05869

Exact name of registrant as specified in its charter:

SUPERIOR UNIFORM GROUP, INC.

Address of principal executive offices:

10055 Seminole Boulevard

Seminole, Florida 33772-2539

Registrant's telephone number, including area code:

727-397-9611

Former name, former address and former fiscal year, if changed since last report: ___________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]      No [_]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X]      No [_]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [_]      No [X]

As of October 24, 2016, the registrant had 14,436,352 shares of common stock outstanding, which is the registrant's only class of common stock.

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

SUPERIOR UNIFORM GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREE MONTHS ENDED SEPTEMBER 30,

(Unaudited)

See accompanying notes to consolidated interim financial statements.

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

SUPERIOR UNIFORM GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

NINE MONTHS ENDED SEPTEMBER 30,

(Continued)

(Unaudited)

See accompanying notes to consolidated interim financial statements.

SUPERIOR UNIFORM GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

*   Inventories consist of the following:

See accompanying notes to consolidated interim financial statements.

SUPERIOR UNIFORM GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30,

(Unaudited)

See accompanying notes to consolidated interim financial statements.

SUPERIOR UNIFORM GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015

(Unaudited)

NOTE 1 – Summary of Significant Interim Accounting Policies:

The Company records revenue as products are shipped and title passes and as services are provided. A provision for estimated returns and allowances is recorded based on historical experience and current allowance programs.

Costs and expenses other than product costs are charged to income in interim periods as incurred, or allocated among interim periods based on an estimate of time expired, benefit received or activity associated with the periods. Procedures adopted for assigning specific cost and expense items to an interim period are consistent with the basis followed by the registrant in reporting results of operations at annual reporting dates. However, when a specific cost or expense item charged to expense for annual reporting purposes benefits more than one interim period, the cost or expense item is allocated to the interim periods.

The Company amortizes identifiable intangible assets on a straight-line basis over their expected useful lives. Amortization expense for other intangible assets was $607,000 and $516,000 for the three-month periods ended September 30, 2016 and 2015, respectively, and $1,761,000 and $1,549,000 for the nine-month periods ended September 30, 2016 and 2015, respectively.

The Company expenses advertising costs as incurred. Advertising costs for the three-month periods ended September 30, 2016 and 2015, respectively were $23,000 and $11,000. Advertising costs for the nine-month periods ended September 30, 2016 and 2015, respectively were $55,000 and $101,000.

The Company includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with in-bound and out-bound freight are generally recorded in cost of goods sold. Other shipping and handling costs such as labor and overhead are included in selling and administrative expenses and totaled $2,646,000 and $2,443,000 for the three months ended September 30, 2016 and 2015, respectively. Other shipping and handling costs included in selling and administrative expenses totaled $7,798,000 and $7,069,000 for the nine months ended September 30, 2016 and 2015, respectively.

Inventories at interim dates are determined by using both perpetual records on a first-in, first-out basis and gross profit calculations.

The provision for income taxes is calculated by using the effective tax rate anticipated for the full year.

The Company recognizes settlement gains and losses in its financial statements when the cost of all settlements in a year is greater than the sum of the service cost and interest cost components of net periodic pension cost for the plan for the year.

Historical basic per share data is based on the weighted average number of shares outstanding. Historical diluted per share data is reconciled by adding to weighted average shares outstanding the dilutive impact of the exercise of outstanding stock options, stock appreciation rights, unvested shares, and performance shares.

Awards to purchase approximately 150,000 and 144,000 shares of common stock with weighted average exercise prices of $18.65 and $17.71 per share were outstanding during the three-month periods ending September 30, 2016 and 2015, respectively, but were not included in the computation of diluted EPS because the awards’ exercise prices were greater than the average market price of the shares of common stock.

Awards to purchase approximately 165,000 and 97,000 shares of common stock with weighted average exercise prices of $18.53 and $18.19 per share were outstanding during the nine-month periods ending September 30, 2016 and 2015, respectively, but were not included in the computation of diluted EPS because the awards’ exercise prices were greater than the average market price of the shares of common stock.

The Company uses certain financial derivatives to mitigate its exposure to volatility in interest rates. The Company records derivatives on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. On the date a derivative contract is entered into, the Company may elect to designate the derivative as a fair value hedge, a cash flow hedge, or the hedge of a net investment in a foreign operation. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative that is used in the hedging transaction is highly effective. For those instruments that are designated as a cash flow hedge and meet certain documentary and analytical requirements to qualify for hedge accounting treatment, changes in the fair value for the effective portion are reported in other comprehensive income (“OCI”), net of related income tax effects, and are reclassified to the income statement when the effects of the item being hedged are recognized in the income statement. The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. In situations in which the Company does not elect hedge accounting or hedge accounting is discontinued and the derivative is retained, the Company carries or continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent changes in its fair value through earnings.

The nature of the Company’s business activities involves the management of various financial and market risks, including those related to changes in interest rates. The Company does not enter into derivative instruments for speculative purposes. The Company manages market and credit risks associated with its derivative instruments by establishing and monitoring limits as to the types and degree of risk that may be undertaken, and by entering into transactions with high-quality counterparties. As of September 30, 2016, the Company’s derivative counterparty had investment grade credit ratings.

In July 2013, the Company entered into an interest rate swap agreement whereby the interest rate payable by the Company on a portion of the outstanding balance of the term loan was effectively converted to a fixed rate beginning July 1, 2014. The Company entered into this interest rate swap arrangement to mitigate future interest rate risk associated with its borrowings and has designated it as a cash flow hedge. (See Note 2).

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Total comprehensive income represents the change in equity during a period from sources other than transactions with shareholders and, as such, includes earnings. For the Company, the only other components of total comprehensive income are the change in pension costs, change in fair value of qualifying hedges, and foreign currency translation adjustments.

Accounting standards require disclosures of certain information about operating segments and about products and services, geographic areas in which the Company operates, and their major customers. The Company has evaluated its operations and has determined that it has two reportable segments – uniforms and related products and remote staffing solutions. (See Note 6).

The Company awards share-based compensation as an incentive for employees to contribute to the Company’s long-term success. Historically, the Company has granted options, stock settled stock appreciation rights, and restricted stock. In 2016, the Company began granting performance shares as well.

Stock options and SARS

The Company grants stock options and stock settled SARS to employees that allow them to purchase shares of the Company’s common stock. Options are also granted to outside members of the Board of Directors of the Company. The Company determines the fair value of stock options and SARS at the date of grant using the Black-Scholes valuation model.

All options and SARS vest immediately at the date of grant. Awards generally expire five years after the date of grant with the exception of options granted to outside directors, which expire ten years after the date of grant. The Company issues new shares upon the exercise of stock options and SARS.

A summary of stock option transactions during the nine months ended September 30, 2016 follows: 

At September 30, 2016, options outstanding, all of which were fully vested and exercisable, had an aggregate intrinsic value of $9,276,000. The weighted-average remaining contractual term was 40 months.

During the three-month periods ended September 30, 2016 and 2015, respectively, the Company received $327,000 and $118,000 in cash from stock option exercises. Additionally, during the three-month periods ended September, 30, 2016 and 2015, respectively, the Company received 2,164 and 6,806 shares of its common stock as payment of the exercise price in the exercise of stock options for 5,568 and 22,792 shares. No tax benefit was recognized for these exercises, as the options exercised were qualified incentive stock options.

During the nine-month periods ended September 30, 2016 and 2015, respectively, the Company received $1,109,000 and $1,501,000 in cash from stock option exercises. Additionally, during the nine-month periods ended September 30, 2016 and 2015, respectively, the Company received 12,598 and 14,571 shares of its common stock as payment of the exercise price in the exercise of stock options for 35,984 and 50,224 shares of its common stock related to the exercise of stock options. No tax benefit was recognized for these exercises, as the options exercised were qualified incentive stock options.

A summary of SARS transactions during the nine months ended September 30, 2016 follows:

At September 30, 2016, SARS outstanding, all of which were fully vested and exercisable, had an aggregate intrinsic value of $3,351,000. The weighted-average remaining contractual term was 27 months.

There were -0- and 54,208 SARS exercised during the three-month periods ended September 30, 2016 and 2015, respectively. SARS exercised during the three-month periods ended September 30, 2015 had an intrinsic value of $671,000.

There were 75,792 and 193,750 SARS exercised during the nine-month periods ended September 30, 2016 and 2015, respectively. SARS exercised during the nine-month periods ended September 30, 2016 and 2015, had intrinsic values of $928,000 and $2,602,000, respectively. There were 58,108 and 53,292 SARS granted during the nine-month periods ended September 30, 2016 and 2015, respectively. The weighted average grant date fair values of the Company’s SARS granted during the nine-month periods ended September 30, 2016 and 2015 were $4.49 and $5.20, respectively.

The following tables summarize significant assumptions utilized to determine the fair value of options and SARS. 

Restricted Stock

The Company has granted restricted stock to directors and certain employees under the terms of the 2013 Plan which confer the right to receive shares of the Company’s stock at a specified future date or when certain conditions are met. These grants generally vest after a three year period. The shares are subject to accelerated vesting under certain circumstances as outlined in the 2013 Plan. Expense for each of these grants is based on the fair value at the date of the grant and is being recognized on a straight-line basis over the respective service period. As of September 30, 2016, the Company had $188,000 of unrecognized compensation cost related to nonvested grants expected to be recognized over the weighted service period of 0.5 years.

A summary of restricted stock transactions during the nine months ended September 30, 2016 follows:

Performance Shares

In 2016, the Compensation Committee of the Board of Directors approved grants of performance shares under the terms of the 2013 Plan. Under the terms of the grants, certain employees received service-based or service-based and performance-based shares. The service-based awards vest after the service period is met which is generally three to five years.  Expense for these grants is based on the fair value on the date of the grant and is being recognized on a straight-line basis over the respective service period. The performance-based shares generally vest after five years if the performance and service targets are met. The Company evaluates the performance conditions associated with these grants each reporting period to determine the expected number of shares to be issued. Based upon this evaluation, expected expenses for these grants are being recognized based on the fair value on the date of the grant on a straight-line basis over the respective service period. The shares are subject to accelerated vesting under certain circumstances as outlined in the 2013 Plan. As of September 30, 2016, the Company had $1,198,000 of unrecognized compensation cost related to nonvested grants expected to be recognized over the weighted average service period of 4.3 years.

A summary of performance share transactions during the nine months ended September 30, 2016 follows:

On December 29, 2014, the Board of Directors declared a 2-for-1 stock split of the Company’s common stock. The record date of the split was January 12, 2015, and the stock split became effective February 4, 2015. All share and per share information in these consolidated interim financial statements have been restated for all periods presented, giving retroactive effect to the stock split. The Company revised certain historical amounts when it recorded the 2-for-1 stock split. The amounts were immaterial and reclassified within shareholders’ equity between par value and additional paid in capital.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) that will supersede most current revenue recognition guidance, including industry-specific guidance. The core principle of the new guidance is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. Additionally, the guidance requires disaggregated disclosures related to the nature, amount, timing, and uncertainty of revenue that is recognized. The amendments are required to be adopted by the Company on January 1, 2018. Transition to the new guidance may be done using either a full or modified retrospective method. The Company is currently evaluating the full effect that the adoption of this standard will have on the Company’s consolidated financial statements.

NOTE 2 - Long-Term Debt:

Effective July 1, 2013, the Company entered into an amended and restated 5-year credit agreement with Fifth Third Bank that made available to the Company up to $15,000,000 on a revolving credit basis (the “Initial Credit Facility”) in addition to a $30,000,000 term loan utilized to finance the acquisition of substantially all of the assets of HPI Direct, Inc.

Effective March 8, 2016, the Company entered into an amended and restated 5-year credit agreement with Fifth Third Bank (the “Amended Credit Agreement”) that increased its revolving credit facility from $15,000,000 to $20,000,000 (the “Amended Credit Facility”) and refinanced its then-existing term loan with a new $45,000,000 term loan to help finance the acquisition of substantially all of the assets of BAMKO, Inc. Interest is payable on the new term loan at LIBOR plus 0.85% (1.38% at September 30, 2016) and on the revolving credit facility at LIBOR (rounded up to the next 1/8^th of 1%) plus 0.85% (1.48% at September 30, 2016). Both loans are based upon the one-month LIBOR rate for U.S. dollar based borrowings. The Company pays a commitment fee of 0.10% per annum on the average unused portion of the commitment under the Amended Credit Facility. The available balance under the Amended Credit Facility is reduced by outstanding letters of credit. As of September 30, 2016, there was $-0- outstanding under letters of credit.

In order to reduce interest rate risk on its debt, the Company entered into an interest rate swap agreement with Fifth Third Bank, N.A. in July 2013 that was designed to effectively convert or hedge the variable interest rate on a portion of its borrowings to achieve a net fixed rate of 2.53% per annum, beginning July 1, 2014 with a notional amount of $14,250,000. The notional amount of the interest rate swap is reduced by the scheduled amortization of the principal balance of the original term loan of $187,500 per month through July 1, 2015 and $250,000 per month through June 1, 2018 with the remaining notional balance of $3,250,000 to be eliminated on July 1, 2018. Effective at the inception of the new term loan, the fixed rate on the notional amount was reduced to 2.43%.

The Company’s obligations under the Amended Credit Agreement are secured by substantially all of the operating assets of Superior Uniform Group, Inc. and are guaranteed by all domestic subsidiaries of Superior Uniform Group, Inc. The agreement contains restrictive provisions concerning a maximum funded senior indebtedness to EBITDA ratio as defined in the agreement (3.5:1), a maximum funded indebtedness to EBITDA ratio as defined in the agreement (4.0:1) and fixed charge coverage ratio (1.25:1). The Company is in full compliance with all terms, conditions and covenants of the Amended Credit Agreement.

NOTE 3 – Periodic Pension Expense:

The following table presents the net periodic pension expense under the Company's plans for the following periods:

Effective June 30, 2013, the Company no longer accrues additional benefits for future service or for future increases in compensation levels for the Company’s primary defined benefit pension plan.

Effective December 31, 2014, the Company no longer accrues additional benefits for future service for the Company’s hourly defined benefit plan.

There were $500,000 and $1,000,000 in contributions made to the Company’s defined benefit plans during the nine-month periods ended September 30, 2016 and 2015, respectively.

NOTE 4 – Supplemental Cash Flow Information:

Cash paid for income taxes was $3,927,000 and $5,274,000, respectively, for the nine-month periods ended September 30, 2016 and 2015. Cash paid for interest was $512,000 and $357,000, respectively, for the nine-month periods ended September 30, 2016 and 2015.

During the nine months ended September 30, 2016 and 2015, respectively, the Company received 12,598 and 14,571 shares of its common stock as payment of the exercise price in the exercise of stock options for 35,984 and 50,224 shares. 

NOTE 5 – Contingencies:

The Company is involved in various legal actions and claims arising from the normal course of business. In the opinion of management, the ultimate outcome of these matters will not have a material impact on the Company’s results of operations, cash flows, or financial position.                                        

NOTE 6 – Operating Segment Information:

The Company classifies its businesses into two operating segments based on the types of products and services provided. The Uniforms and Related Products segment consists of the sale of uniforms and related items, including promotional products. The Remote Staffing Solutions segment consists of sales of staffing solutions.

The Company evaluates the performance of each operating segment based on several factors of which the primary financial measures are operating segment net sales and income before income taxes. The accounting policies of the operating segments are the same as those described in Note 1 entitled Summary of Significant Interim Accounting Policies. Amounts for corporate expenses are included in the Uniforms and Related Products segment totals. Information related to the operations of the Company's operating segments is set forth below. 

NOTE 7 – Acquisition of Business:

On March 8, 2016, the Company closed on the acquisition of substantially all of the assets of BAMKO, Inc. (“BAMKO”). The transaction had an effective date of March 1, 2016. BAMKO is a full-service merchandise sourcing and promotional products company based in Los Angeles, CA. With sales offices in the United States, England and Brazil, as well as support offices in China, Hong Kong, and India, BAMKO serves many of the world’s most successful brands. The purchase price for the asset acquisition consists of approximately $15,800,000 in cash, subject to adjustment, the issuance of approximately 324,000 restricted shares of Superior Uniform Group, Inc.’s common stock that will vest over a five year period, the potential future payment of approximately $5,500,000 in additional contingent consideration through 2021, and the assumption of certain liabilities of BAMKO. The transaction also includes the acquisition of BAMKO’s subsidiaries in Hong Kong, China, Brazil and England as well as an affiliate in India.

The foregoing description of the asset purchase agreement does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the agreement, which is filed as an exhibit to the Quarterly Report on Form 10-Q filed on April 28, 2016. The agreement has been attached to provide investors with information regarding its terms. It is not intended to modify or supplement any factual disclosures about the Company in its public reports filed with the Securities and Exchange Commission and it is not intended to be, and should not be relied upon as, disclosure regarding any facts and circumstances relating to the Company or BAMKO. In particular, the representations, warranties and covenants set forth in the agreement (a) were made solely for purposes of the agreement and solely for the benefit of the contracting parties, (b) may be subject to limitations agreed upon by the contracting parties, including being qualified by confidential disclosures made to a contracting party in connection with the agreement, (c) in certain cases, will survive for only a limited period of time, (d) are qualified in certain circumstances by a materiality standard which may differ from what may be viewed as material by investors, (e) were made only as of the date of the agreement or such other date as is specified in the agreement, and (f) may have been included in the agreement for the purpose of allocating risk between the parties rather than establishing matters as facts. Investors are not third-party beneficiaries under the agreement, and should not rely on the representations, warranties and covenants or any descriptions thereof as characterizations of the actual state of facts or conditions of the parties. Moreover, information concerning the subject matter of the representations and warranties may change after the date of the agreement, which subsequent information may or may not be fully reflected in subsequent public disclosures. Accordingly, the representations and warranties in the agreement should not be viewed or relied upon as statements of actual facts or the actual state of affairs of the Company or any of its subsidiaries or affiliates.

Fair Value of Consideration Transferred

A summary of the purchase price is as follows:

Assets Acquired and Liabilities Assumed

The total purchase price was allocated to the acquired tangible and intangible assets and assumed liabilities of BAMKO based on their estimated fair values as of March 1, 2016. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was allocated to goodwill.

The following table presents the preliminary allocation of the total fair value of consideration transferred, as shown above, to the acquired tangible and intangible assets and assumed liabilities of BAMKO based on their estimated fair values as of the effective date of the transaction.

The assets and liabilities of BAMKO shown below are based on our preliminary estimates of their acquisition effective date fair values. Our final fair value determinations may be significantly different than those shown below.

The following is our preliminary assignment of the aggregate consideration: 

The Company recorded $11,360,000 in identifiable intangibles at fair value, consisting of $2,090,000 in acquired customer relationships, $370,000 in non-compete agreements from the former owners of BAMKO, and $8,900,000 for the acquired trade name.

The estimated value for acquisition-related contingent consideration payable is $5,205,000. The Company will continue to evaluate this liability for remeasurement at the end of each reporting period and any change will be recorded in the Company’s consolidated statement 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.

Goodwill was calculated as the difference between the fair value of the consideration and the preliminary values assigned to the assets acquired and liabilities assumed. The purchase price and goodwill allocation are expected to be finalized during the remainder of 2016 as the Company completes its process of evaluating all relevant data associated with the transaction.

The intangible assets associated with the customer relationships will be amortized for seven years beginning on March 1, 2016 and the non-compete agreement will be amortized for five years and ten months. The trade name is considered an indefinite-life asset and as such will not be amortized.

The Company recognized amortization expense on these acquired intangible assets of $90,000 and $211,000 for the three and nine-month periods ended September 30, 2016, respectively.

For the three and nine-month periods ended September 30, 2016, the Company incurred and expensed transaction related expenses of approximately $44,000 and $1,116,000, respectively. These amounts are included in selling and administrative expenses on the consolidated statements of comprehensive income.

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Certain matters discussed in this Form 10-Q are “forward-looking statements” intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified by use of the words “may”, “will”, “should”, “could”, “expect”, “anticipate”, “estimate”, “believe”, “intend”, “project”, “potential”, or “plan” or the negative of these words or other variations on these words or comparable terminology. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation: (1) projections of revenue, income, and other items relating to our financial position and results of operations, (2) statements of our plans, objectives, strategies, goals and intentions, (3) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (4) statements of expected industry and general economic trends. Such forward-looking statements are subject to certain risks and uncertainties that may materially adversely affect the anticipated results. Such risks and uncertainties include, but are not limited to, the following: general economic conditions, including employment levels, in the areas of the United States in which the Company’s customers are located; changes in the healthcare, industrial, commercial, leisure and public safety industries where uniforms and service apparel are worn; the impact of competition; the price and availability of cotton and other manufacturing materials; our ability to successfully integrate operations following acquisitions; attracting and retaining senior management and key personnel and other factors described in the Company’s filings with the Securities and Exchange Commission, including those described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.  Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements made herein and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Form 10-Q and we disclaim any obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

Critical Accounting Policies

Our significant accounting policies are described in Note 1 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015. Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the estimates that we have made. These estimates are based upon our historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Our actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting estimates are those that we believe require our most significant judgments about the effect of matters that are inherently uncertain. A discussion of our critical accounting estimates, the underlying judgments and uncertainties used to make them and the likelihood that materially different estimates would be reported under different conditions or using different assumptions is as follows:

Allowance for Losses on Accounts Receivable

These allowances are based on both recent trends of certain customers estimated to be a greater credit risk as well as general trends of the entire customer pool. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. An additional impairment in value of one percent of net accounts receivable would require an increase in the allowance for doubtful accounts and would result in additional expense of approximately $413,000.

Inventories

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

Goodwill

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

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

An entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. The Company completed its assessment of the qualitative factors as of December 31, 2015 and determined that it was not more likely than not that the fair value of the reporting unit was less than its carrying value.

Insurance

The Company self-insures for certain obligations related to health insurance programs. The Company also purchases stop-loss insurance policies to protect it from catastrophic losses. Judgments and estimates are used in determining the potential value associated with reported claims and for losses that have occurred, but have not been reported. The Company's estimates consider historical claim experience and other factors. The Company's liabilities are based on estimates, and, while the Company believes that the accrual for loss is adequate, the ultimate liability may be in excess of or less than the amounts recorded. Changes in claim experience, the Company's ability to settle claims or other estimates and judgments used by management could have a material impact on the amount and timing of expense for any period.

Pensions 

The Company’s pension obligations are determined using estimates including those related to discount rates, asset values and changes in compensation. The discount rates used for the Company’s pension plans were determined based on the Citigroup Pension Yield Curve.  This rate was selected as the best estimate of the rate at which the benefit obligations could be effectively settled on the measurement date taking into account the nature and duration of the benefit obligations of the plans using high-quality fixed-income investments currently available (rated AA or better) and expected to be available during the period to maturity of the benefits. The 8% expected return on plan assets was determined based on historical long-term investment returns as well as future expectations given target investment asset allocations and current economic conditions.

Income Taxes

Share-based Compensation

Business Outlook

Uniforms and Related Products

Historically, we have manufactured and sold a wide range of uniforms, career apparel and accessories, which comprises our Uniforms and Related Products segment.  Our primary products are provided to workers employed by our customers and, as a result, our business prospects are dependent upon levels of employment and overall economic conditions, among other factors.  Our revenues are impacted by our customers’ opening and closing of locations and reductions and increases in headcount. Additionally, between 2009 and 2013 voluntary employee turnover had declined significantly because fewer alternative jobs were available to employees of our customers.  While the current economic environment in the United States remains somewhat sluggish, we are continuing to see an improvement in the employment environment and voluntary employee turnover has been increasing.  We also continue to see an increase in the demand for employees in the healthcare sector as a result of the Affordable Care Act.  These factors are expected to have positive impacts on our prospects for growth in net sales in 2016.

We have continued our efforts to increase penetration of the health care market.  We were awarded our first two group purchasing organization contracts in 2015 and increased the number of healthcare facilities that we are able to pursue for direct sales significantly.  We are strategically working to acquire these potential customers and to grow our healthcare business over the next several years.  We continue to refine our approach to this market as we gain additional experience and data in the market.  We expect to be awarded additional agreements for other group purchasing organizations in the future.

We have been and continue to actively pursue acquisitions to increase our market share in the Uniforms and Related Products segment.  During the first quarter of 2016 we acquired substantially all of the assets of BAMKO, Inc. to strengthen our position in the promotional products and branded merchandise market as we believe this product line is a synergistic fit with our uniform business.

Remote Staffing Solutions

We are pursuing a diversified business model to include growth of our Remote Staffing Solutions segment, operating in El Salvador, Belize, and the United States.  This business segment was initially started to provide remote staffing services for the Company at a lower cost structure in order to improve our own operating results.   It has in fact enabled us to reduce our operating expenses in our Uniforms and Related Products segment and to more effectively service our customers’ needs in that segment.  We began selling remote staffing services to other companies at the end of 2009. We have grown this business from approximately $1,000,000 in net sales to outside customers in 2010 to approximately $12,000,000 in net sales to outside customers in 2015.  We have spent significant effort over the last several years improving the depth of our management infrastructure in this segment to support significant growth in this segment in 2016 and beyond.  We increased net sales to outside customers in this segment by approximately 49% in 2015 as compared to 2014 and by approximately 42% in 2014 as compared to 2013.

Results of Operations

Remote Staffing Solutions net sales increased 10.9% before intersegment eliminations and 13.9% after intersegment eliminations for the three months ended September 30, 2016 compared to the same period in the prior year.  These increases are attributed to continued market penetration in 2016, both with respect to new and existing customers.

Remote Staffing Solutions net sales increased 18.1% before intersegment eliminations and 24.4% after intersegment eliminations for the nine months ended September 30, 2016, compared to the same period in the prior year.  These increases are attributed to continued market penetration in 2016, both with respect to new and existing customers.

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products segment was 65.5% for the three months ended September 30, 2016 and 67.1% in the comparable period for 2015.  The decrease in 2016 is primarily attributed to a decrease in direct product costs as a percentage of net sales on non BAMKO sales during 2016 (contributing 1.8%) and lower cost of goods sold on BAMKO sales as a percentage of net sales (contributing 0.1%), partially offset by an increase in overhead costs as a percentage of net sales on non BAMKO sales (contributing 0.3%).

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products segment was 66.4% for the nine months ended September 30, 2016 and 67.0% for the comparable period in 2015. The decrease in 2016 is primarily attributed to a decrease in direct product costs as a percentage of net sales on non BAMKO sales during 2016 (contributing 0.6%) and lower cost of goods sold on BAMKO sales as a percentage of net sales (contributing 0.1%) partially offset by an increase in overhead costs as a percentage of net sales on non BAMKO sales (contributing 0.1%).

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions segment was 46.7% for the three months ended September 30, 2016, and 46.1% in the comparable period for 2015.  The increase in the percentage of cost of goods sold is not considered significant.

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions segment was 46.2% for the nine months ended September 30, 2016, and 44.3% in the comparable period for 2015.  The percentage increase in 2016 as compared to 2015 is primarily attributed to an increase in the percentage of segment revenue coming from the domestic portion of our Remote Staffing Solutions segment from 21.3% in the nine month period ended September 30, 2015 to 29.6% in the comparable period of 2016. The hourly rates charged for domestic services are higher than offshore services but the margin percentage earned is lower.

Interest expense increased from $130,000 for the three months ended September 30, 2015 to $172,000 for the three months ended September 30, 2016. This increase is attributed primarily to higher average borrowings outstanding in the three months ended September 30, 2016 primarily due to the BAMKO acquisition.

Interest expense increased from $395,000 for the nine months ended September 30, 2015 to $512,000 for the nine months ended September 30, 2016. This increase is attributed primarily to higher average borrowings outstanding in the nine months ended September 30, 2016 primarily due to the BAMKO acquisition.

The Company’s effective tax rate for the nine months ended September 30, 2016 was 30.7% versus 31.7% for the nine months ended September 30, 2015. The 1.0% decrease in such effective tax rate is attributed primarily to an increase in the benefit related to federal tax credits (0.8%) and other items (0.2%).

Liquidity and Capital Resources

Accounts receivable-trade increased 38.2% from $29,914,000 on December 31, 2015 to $41,335,000 on September 30, 2016. Approximately $4,885,000 of this increase is attributed to trade receivables acquired as part of the BAMKO acquisition effective March 1, 2016. The balance of the increase is attributed primarily to higher sales in the last month of the current quarter versus the last month of the fourth quarter of 2015.

Prepaid expenses and other current assets increased 71.4% from $6,214,000 on December 31, 2015 to $10,650,000 as of September 30, 2016. This increase is primarily attributed to assets acquired as part of the BAMKO acquisition of $3,200,000 effective March 1, 2016 with the balance primarily related to timing of payments for prepaid deposits and other miscellaneous prepaid expenses.

Inventories increased 3.4% from $63,573,000 on December 31, 2015 to $65,713,000 as of September 30, 2016.  This increase is primarily due to inventory requirements to meet higher sales and due to the acquisition of $236,000 of inventory received as part of the BAMKO acquisition.

Other intangible assets increased 67.5% from $14,222,000 on December 31, 2015 to $23,821,000 on September 30, 2016.  This increase is attributed to other intangible assets acquired as part of the BAMKO acquisition effective March 1, 2016 of $11,360,000, partially offset by scheduled amortization.

Accounts payable increased 24.5% from $11,775,000 on December 31, 2015 to $14,658,000 on September 30, 2016.  This increase is primarily due to the timing of inventory purchases and $1,314,000 in accounts payable assumed as part of the BAMKO acquisition.

Other current liabilities increased 18.1% from $8,307,000 on December 31, 2015 to $9,812,000 on September 30, 2016. The increase is primarily due to $736,000 of other current liabilities assumed as part of the BAMKO acquisition and, an increase of $367,000 in accrued self-insured medical costs.

Long-term acquisition related contingencies increased by 86.4% from $3,866,000 on December 31, 2015 to $7,205,000 as of September 30, 2016. This increase is primarily due to $5,205,000 of contingent liability recorded as part of the BAMKO acquisition and the accretion of the liabilities as we move closer to the scheduled payment dates partially offset by the transfer of the $1,978,000 balance expected to be paid in April 2017 to current liabilities. The contingent liability recorded as part of the BAMKO acquisition reflects liabilities specified in the asset purchase agreement for contingent consideration subject to a number of conditions, including the acquired business exceeding specified earnings targets, which is subject to acceleration upon the occurrence of certain events specified in the asset purchase agreement.

The Company will continue to evaluate its contingent liabilities for remeasurement at the end of each reporting period and any change will be recorded in the Company’s consolidated statement of comprehensive income. The carrying amount of the contingent liabilities may fluctuate significantly and actual amounts paid may be materially different from the estimated value of the liability.

Cash and cash equivalents increased by $1,764,000 from $1,036,000 on December 31, 2015 to $2,800,000 as of September 30, 2016. During the nine-months ended September 30, 2016, the Company generated cash of $6,171,000 in operating activities, used cash of $21,757,000 in investing activities, including $15,161,000, net of cash acquired, related to the acquisition of BAMKO; and used $6,596,000 for additions to property, plant and equipment, with approximately $3,562,000 related to the new building project in El Salvador and the balance related to normal recurring additions; and generated $17,259,000 from financing activities.

In the foreseeable future, the Company will continue its ongoing capital expenditure program designed to maintain and improve its facilities. As noted in prior periods, we have invested in a new call center building in El Salvador which was completed in June 2016 that almost triples our existing capacity there. We spent approximately $6,000,000 on the El Salvador project through December 31, 2015 and approximately $3,562,000 in the nine-month period ended September 30, 2016. The Company at all times evaluates its capital expenditure program in light of prevailing economic conditions.

During the nine-months ended September 30, 2016 and 2015 respectively, the Company paid cash dividends of $3,487,000 and $3,128,000. The Company reacquired 20,100 shares of its common stock at a total cost of $316,000 in the nine-month period ended September 30, 2016, pursuant to its stock repurchase program. No stock was reacquired in the nine-month period ended September 30, 2015.

Effective July 1, 2013, the Company entered into an amended and restated 5-year credit agreement with Fifth Third Bank that made available to the Company up to $15,000,000 on a revolving credit basis (the “Initial Credit Facility”) in addition to a $30,000,000 term loan utilized to finance the acquisition of substantially all of the assets of HPI Direct, Inc.

In order to reduce interest rate risk on its debt, the Company entered into an interest rate swap agreement with Fifth Third Bank, N.A. in July 2013 that was designed to effectively convert or hedge the variable interest rate on a portion of its borrowings to achieve a net fixed rate of 2.53% per annum, beginning July 1, 2014 with a notional amount of $14,250,000. The notional amount of the interest rate swap is reduced by the scheduled amortization of the principal balance of the original term loan of $187,500 per month through July 1, 2015 and $250,000 per month through June 1, 2018 with the remaining notional balance of $3,250,000 to be eliminated on July 1, 2018. Effective at the inception of the new term loan, the fixed rate on the notional amount was reduced to 2.43%.

Under the terms of the interest rate swap, the Company receives variable interest rate payments and makes fixed interest rate payments on an amount equal to the notional amount at that time. Changes in the fair value of the interest rate swap designated as the hedging instrument that effectively offset the variability of cash flows associated with the variable-rate, long-term debt obligation are reported in OCI, net of related income tax effects. As a result of the acquisition of BAMKO on March 8, 2016, the original term loan associated with this hedge was paid in full and replaced with the new $45,000,000 term loan discussed above. At that time, the Company undesignated the original term loan as the hedged instrument and elected the new term loan as the designated hedged instrument. The negative fair value of the interest rate swap at that time of $152,000 will be amortized as an expense over the remaining life of the swap agreement. At September 30, 2016, the interest rate swap had a negative fair value of $95,000, which is presented within other current liabilities within the consolidated balance sheet. Approximately $38,000 of this cumulative loss has been recognized in earnings in 2016. The balance of $95,000, net of tax benefit of $34,000, since the inception of the hedge in July 2013 has been recorded within the OCI through September 30, 2016. The Company expects that approximately $65,000 of these losses will be reclassified into earnings over the subsequent twelve-month period

The remaining scheduled amortization for the term loan is as follows: 2016 $1,071,000; 2017 through 2020 $6,429,000 per year; 2021 $14,463,000. The term loan does not include a prepayment penalty. In connection with the Amended Credit Agreement, the Company incurred approximately $70,000 of debt financing costs, which primarily consisted of legal fees. These costs are being amortized over the life of the Amended Credit Agreement and are recorded as additional interest expense.

The Company’s obligations under the Amended Credit Agreement are secured by substantially all of the operating assets of Superior Uniform Group, Inc. and are guaranteed by all domestic subsidiaries of Superior Uniform Group, Inc. The agreement contains restrictive provisions concerning a maximum funded senior indebtedness to EBITDA ratio as defined in the agreement (3.5:1), a maximum funded indebtedness to EBITDA ratio as defined in the agreement (4.0:1) and a fixed charge coverage ratio (1.25:1). The Company is in full compliance with all terms, conditions and covenants of the Amended Credit Agreement.

The Company believes that income generated from operations and outside sources of credit, both trade and institutional, will be adequate to fund its operations for the remainder of the year and for the foreseeable future.

Not applicable.

ITEM 4.       Controls and Procedures

Disclosure Controls and Procedures

The Company conducted an evaluation, under supervision and with the participation of the Company’s principal executive officer, Michael Benstock, and the Company’s principal financial officer, Andrew D. Demott, Jr., of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report (the “Evaluation Date”). Based on such evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were effective to ensure that information the Company is required to disclose in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1.       Legal Proceedings

None.

ITEM 1A.    Risks Relating To Our Industry

For example, during the latter part of 2010, cotton prices began increasing dramatically and reached historically high levels during 2011 due to weather-related and other supply disruptions, which when combined with robust global demand, particularly in Asia, created concerns about availability and increased costs for our products. While we were able to pass on a portion of these price increases to our customers during most of 2011, we saw a negative impact on our gross margins from the fourth quarter of 2011 through 2012.

Any increase in raw material prices increases our cost of sales and can decrease our profitability unless we are able to pass the costs on to our customers in the form of higher prices. In addition, if one or more of our competitors is able to reduce their production costs by taking advantage of any reductions in raw material prices or favorable sourcing agreements, we may face pricing pressures from those competitors and may be forced to reduce our prices or face a decline in net sales, either of which could have a material adverse effect on our business, results of operations and financial condition.

ITEM 2.       Unregistered Sales of Equity Securities and Use of Proceeds

There were no unregistered sales of equity securities during the quarter ended September 30, 2016 that were not previously reported in a current report on Form 8-K.

The table below sets forth the information with respect to purchases made by or on behalf of Superior Uniform Group, Inc. or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of our common shares during the three months ended September 30, 2016. 

(1) On August 1, 2008, the Company’s Board of Directors approved an increase to the outstanding authorization to allow for the repurchase of 1,000,000 shares of the Company’s outstanding shares of 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 such purchases were open market transactions.

Under our credit agreement with Fifth Third Bank, if an event of default exists, we may not make distributions to our shareholders. The Company is in full compliance with all terms, conditions and covenants of the Amended Credit Agreement.

ITEM 3.      Defaults upon Senior Securities

Not applicable.

ITEM 4.      Mine Safety Disclosures

Not applicable.

ITEM 5.      Other Information

None.

ITEM 6.      Exhibits

See Exhibit Index.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBIT INDEX