Superior Group of Companies, Inc.

Good afternoon, everyone. Welcome to the Superior Group of Companies second quarter 2023 conference call. With us today are Michael Benstock, the company's chief executive officer, and Mike Kemple, the chief financial officer. As a reminder, this conference call is being recorded. This call may contain forward-looking statements regarding the company's plans, initiatives, and strategies, and the anticipated financial performance of the company, including but not limited to sales and revenue. Such statements are based upon management's current expectations, projections, estimates, and assumptions. Words such as expect, believe, anticipate, think, outlook, hope, and variations or such words and similar expressions identify such forward-looking statements. Forward-looking statements involve known and unknown risks and uncertainties that may cause future results to differ materially from those suggested by the forward-looking statements. Such risks and uncertainties are further disclosed in the company's periodic filings with the Securities and Exchange Commission, including, but not limited to, the company's most recent annual report on Form 10-K and the quarterly reports on Form 10-Q. 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 company does not undertake to update the forward-looking statements contained herein except as required by law. And now, I'll turn the call over to Mr. Michael Benstock. Please go ahead.

Thank you, Operator, and thank you, everyone, for joining today's call. I'll begin by reviewing our second quarter highlights on a consolidated basis, including an update on our strategy to navigate the current economic uncertainty and ultimately position the company to capitalize on the compelling growth opportunities ahead. I'll then review our three business segments and our various initiatives to more profitably grow each business. Mike will then provide more detail on second quarter results along with an update on our full year outlook, We'll then open the call for Q&A. We generated consolidated second quarter revenues of $129 million compared to $148 million for the same period last year, along with consolidated second quarter adjusted EBITDA of $7 million compared to $5 million in the prior year quarter, which excludes last year's non-cash impairment charges. Our overall financial performance was consistent with the soft market conditions described in our last quarterly call. In the midst of a challenging market environment, our team remained focused on delivering on our commitment to drive positive cash flow and strengthen our balance sheet. As a result, we generated operating cash flow of $38 million for the first six months of the year, reduced working capital, and improved our leverage ratio while also strategically investing in the attractive addressable markets across all three of our business segments. As a result, we believe SGC is in a better position to capitalize on improved sales trend in the second half of the year and beyond, as macro softness and uncertainty ultimately gives way to better economic times. With that, let's take a closer look at each of our three business segments. Healthcare apparel, which primarily includes the Wink and Fashion Seal healthcare brands, generated second quarter revenues of $28 million, up from $26 million in the prior year second quarter. This 7 percent increase came despite the continued soft conditions across the healthcare market. Second quarter adjusted EBITDA of $1.9 million improved from negative $1.4 million in the year-ago period, which included significant inventory write-downs last year, as you may recall. Consistent with what I've mentioned on our past two earnings calls, we have made and will continue to make progress towards achieving better inventory equilibrium. As a reminder, healthcare apparel is a large and growing addressable market, and our overarching strategy involves growing our market share well in excess of the 2 million-plus caregivers who already wear our brands every single day. Since the launch of our direct-to-consumer website featuring our Wink product line early in the second quarter, results have remained above expectations. By adding the D2C channel to our business, we have been able to drive higher consumer awareness and engagement with our brand. Another strategy within healthcare apparel is the recent launch of our B2B website, designed to allow wholesale accounts to engage with us more efficiently. Wrapping up on healthcare apparel, we see attractive long-term growth opportunities that continue to expect stronger year-over-year results, which have already begun. Next up is branded products, which is our largest segment, generating revenues of $80 million during the second quarter versus $102 million a year ago, consistent with the softness that we outlined on our last call. Branded Products' second quarter adjusted EBITDA of $7 million was up slightly over last year, with last year's result reflecting PPE-related inventory write-downs. While top-line headwinds caused by economic uncertainty continue, Branded Products is another segment which we're effectively managing through this period by improving gross margins, carefully managing expenses, and developing new sales strategies to overcome the macro environment. In other words, We're focusing on what's within our control, and these actions will leave us well-positioned to capitalize on future growth as the economy improves over time. Our long-term vision for branded products is to expand our market share currently less than 2% in this attractive and growing $26 billion marketplace. Let's move on to contact centers, our highest margin segment. Second quarter revenues were $23 million, up 6% over the past year, with adjusted EBITDA $3.3 million, reflecting a margin of 14%, slightly improved from the first quarter. Relative to adjusted EBITDA $4.9 million a year earlier, this quarter reflects higher labor costs and the investments in talent, technology, and infrastructure during the second half of 2022, partially offset by price increases that were implemented at the end of the first quarter. We continue to build our pipeline of new business while identifying further pricing opportunities. Our long-term plan is to continue to significantly grow the office gurus, tapping into the large addressable market for contact centers while aiming for EBITDA margins in the high teams. I'll now turn the call over to Mike before we take Q&A. Mike?

Thank you, Michael, and thanks, everyone, for joining today. Second quarter results were consistent with the quarterly cadence we described in our call in May. and we continue to expect a back-end loaded year. We generated consolidated revenue of $129 million compared to $148 million in the prior year quarter. Our gross margin expanded to 36.8% of 430 basis points over the past year. This improved gross margin was primarily driven by last year's inventory write-down of $4.5 million. which accounted for 300 basis points of the expansion and a significant improvement in the branded products gross margin rate due to favorable pricing and customer mix. While second quarter SG&A costs of $43 million were improved from last year, SG&A expenses as a percent of sales increased to 33.6% for the quarter compared to 31.1% for the second quarter of 2022. The increase as a percent of sales was due to expense deleverage resulting from the sales decrease in branded products and higher expenses associated with additional headcount and infrastructure costs to support growth in our contact centers segment. Second quarter interest expense of $2.6 million was consistent with the first quarter, but was up $2 million from last year due to higher interest rates. Rounding out our income statement discussion, second quarter net income was $1.2 million, or $0.08 per diluted share, compared to the prior year quarter's net loss of $26.7 million, or $1.70 per diluted share. In the year-ago second quarter of 2022, the company recognized pre-tax non-cash impairment charges related to goodwill and trade names of $30 million, or $28 million set of tax, or $1.78 per diluted share. On an adjusted basis, which excludes the prior year charges, this quarter's net income of $1.2 million, or $0.08 per diluted share, was about flat to last year. Moving on to the balance sheet, our cash and cash equivalents grew slightly since the start of the year. As Michael mentioned, while we navigate challenging market conditions, we have made meaningful progress towards strengthening our balance sheet by continuing to reduce debt and working capital, as well as driving $38 million in operating cash flows through the first two quarters of the year. We remain focused on these areas and will also continue our tight management of expenses and capital expenditures. As a result of these efforts, our net leverage ratio has improved slightly from the first quarter to 3.7 times our trailing 12-month covenant EBITDA and was well within our covenant requirements. Turning to our updated four-year outlook, given the persistence of soft and uncertain macroeconomic conditions, we now expect a revenue range of $550 to $560 million, relative to the range issued in March of $585 to $595 million. For earnings per diluted share, our outlook now reflects $0.45 to $0.55 relative to our original range of $0.92 to $0.97. Note that our updated outlook still calls for a back-end weighted year with both the third and fourth quarters stronger than both quarters in the first half. Finally, on a business segment basis, For healthcare apparel, we continue to expect low single-digit sales growth for the full year that reflects gradual improvement through the balance of the year as inventory levels and customer demand approach normalized levels. For branded products, we expect a high single-digit sales decline for the full year, again, based on an improved sales trend during the second half. Lastly, for contact centers, We anticipate improved sales and profitability in the second half of the year compared to the first and second quarters, resulting in double-digit sales growth in the low teens for the full year. Operator, if you can now open the line, we'd be happy to take questions.

Thank you very much. We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Kevin Steinke with Barrington Research. Please go ahead.

Good afternoon. Just wanted to start off by asking about, you know, what's changed. I know you're still expecting a back half weighted year and an uptrend in the second half year. I'm just kind of curious what you're hearing from your clients on the branded product side that might have, you know, changed your outlook on And if they're just being, I suppose, a little more cautious than previously anticipated.

Yeah, Kevin, hi. Thanks for the question, and I'll jump in. Mike can add anything that he sees. You know, we have started to see some positive signs of budgets opening up in the market in the past few months. You know, the large tech companies continue to report pretty strong earnings, which overall bodes well for us. Our backlogs, in fact, which is representing orders received and not yet delivered, was up significantly June 30th over the end of March. And we're seeing good signs. What we're not seeing is a return to any kind of normalcy that we would have expected sooner than we're seeing it. All the predictions that we heard in the latter part of last year is what we relied most of our first half and second half outlook on. And we expected that the second half would come back a little bit stronger as the economy was predicted to come back stronger. And we seem to be just in this malaise of uncertainty where, you know, some budgets are opening up, some budgets aren't. But, you know, we are seeing positive signs. I think we're taking a conservative approach to this. We don't want to disappoint, and we want to be certain that, you know, our targets are realistic for the second half of the year. Still, second half of the year, if you do the math, is up significant double digits over the first half of the year in order to achieve those results. And I would expect that that will happen at this point. But, you know, it's really a mixed bag. It truly is. We're seeing, you know, within, I spoke about the branded, merchandise branded products in particular. But when you look at the uniform side of that, that's a little bit slower than the branded merchandise is, even though that's a smaller part of our branded product segment today. And then you look at, you know, healthcare was up, in fact, second quarter. but there's still a lot of product in the marketplace that's being sold by our competitors. I have no visibility to how much excess product they have left to sell. I know ours is coming down significantly. We're looking to get past our issue of any kind of, you know, product overhang by the end of this year, which I think we've been pretty clear on. And, you know, lastly, when we get to the call center business, again, Interestingly, Mike can probably share exact statistics a little better than I can, but we did put on a lot of customers in the first half of the year. I think at an unprecedented rate, unfortunately, we also had a lot of customers who cut back on the number of agents that they required because they have uncertainty in their business as well. Mike, you want to jump in on that a little bit?

Sure, yeah, I would just add, Kevin, I mean, Michael covered it well in terms of branded products, nothing to add there. On the contact center business, you'll recall we mentioned at the end of the first quarter that we onboarded quite a few customers in the first quarter, and we certainly saw the benefit of that in the second quarter. And while we still had some growth within our existing customers, we also had some of our customers cut back on seats. And so that cutback with some of our customers is what tempered the growth a little bit in the second quarter. As I noted in my guidance, we expect the sales trend to improve with contact centers as we continue to get the benefit of those added customers plus customers in the pipeline so we feel good about the back half of the year for contact centers.

Great. Thank you for all the insight there. You know, nice job on the cash flow and the financial leverage ratio. That didn't spike up as much or didn't really move as much as I thought it might based on, you know, that amendment to your credit agreement you had executed. So how should we think about leverage and cash flows? We look to the second half of the year and relative to the covenants you have in place for the remainder of this year?

Sure. Yeah, Kevin, I'll say, you know, we clearly exceeded our expectations in the first six months as we talked about really starting last year. really focused on inventory in particular and cutting back on purchasing that we felt would drive improvement this year, and clearly we see that happening. But we're obviously really satisfied with how we ended the first six months. I think there's still room for improvement in the balance of the year, not to the magnitude, obviously, that you've seen the first six months, but inventory levels, while we're making progress, still have more progress to go for the balance of the year, particularly in healthcare. So our expectation is to still make some, let's say, modest improvement balance of the year. And obviously with the improvement that we've made in terms of working capital and the reduction of debt and the improvement in our leverage ratio, we're feeling more comfortable about our covenant position going forward. Still have work to do to hit what Michael and I would say is our target net leverage ratio, which is to be two and a half or lower. That will take some time, but we're obviously feeling more positive as we move forward.

Okay. Well, that's good to hear. So you mentioned some customers and contact centers pulling back on the number of agents and I know you're implementing some price increases to offset some higher labor costs you had seen in that segment. What's the status of pricing there? And, you know, does the fact that there's maybe less demand for agents currently take some of that pressure off of labor costs, at least in the short term?

I'll jump in on that, and then Mike can add again. We're not seeing, you know, we had a few clients who decided to reduce their headcount. And, you know, we haven't lost clients, which is always a good thing. Our expectation, Kevin, is when there's more clarity to the future and when things do turn the corner from an economic standpoint, that we'll get those seats back. In the meantime, you know, that was not contemplated. that we would do the kind of headcount reduction that we did with these few particular customers during Q2. And obviously, you know, that affects our growth overall for the year. And so that's the first part. I wouldn't say that there's a lessened demand for new customers and new agents in the places where we operate. In fact, I would say near shore is as robust as it's ever been. But, you know, when you have close to 300 seats that you've cut back in a single quarter that you're not going to see revenue from those for the remainder of the year, it does impact you. We've tried to redeploy many of those people into other seeds that we have won, and we have won a fair amount of seeds. So we haven't had to really cut back our headcount that much. It's just, you know, it's one offsetting the other. Instead of having growth, we're just basically had to temper our expectations with respect to growth right now because of that.

Okay, thank you.

Okay, you covered it. Okay. Okay. Okay, good, thanks. I just wanted to ask about healthcare apparel. You mentioned some positive early results of the direct-to-consumer initiative and maybe just talk more about how that's trending and how you think that could play out and potentially contribute to the second half of 2023.

Yeah, as we've said in the past, we don't expect it to have a big impact on this year. You know, we did a soft launch in April. I believe it was the end of April. So we've had three and a half months at it so far. Every month is better than the prior month. We're getting much better at, you know, keeping our customer acquisition costs in check and a return on ad spend. where we want it. We're not disclosing what those metrics are because it's not significant enough to really speak about. You know, I would expect that until the latter part of 2024, you're not going to hear us speak about actual numbers. And maybe even beyond that, from a competitive standpoint, we're best off not speaking to that. But I can tell you it is exceeding our expectations. We're very happy with the gross margins it's bringing the business to. We're very happy with our ability to move clearance merchandise through that, which we have a lot of. And so we're excited about the channel, and it is everything we hoped it would be. And I'm looking forward to sometime in the future being able to report when it is a more significant part of our business, which it will be. It's just a question of time.

Okay, thank you for taking the questions. I'll turn it over for now. I'll get back in the queue. Thanks. Thank you.

The next question comes from Jim Sidoti with Sidoti & Company. Please go ahead.

Hi, good afternoon, and thanks for taking the question. Hi, Jim. Hi, Jim. So, you know, you've guided for or you're based on your guidance you know, it sounds like you're looking for the top line to turn around and grow low single digits in the second half of the year after falling, you know, roughly 10% in the beginning of the year. Are you starting to see any evidence of that now in the third quarter, or do you think that's primarily a fourth quarter event?

Yeah, you go ahead, Mike.

Yeah, I'll start. I think, Jim, I think Michael alluded to to this a little bit in the previous question. I think we're seeing signs in our businesses that there is an improvement in the trend from what we saw in Q1 and Q2. In the branded product space, we've seen a trend improvement in the backlog of orders that are coming into the business. We're obviously encouraged with the positive comp in healthcare in the second quarter. Don't want to get ahead of ourselves. There's a lot of the year to go, but the business driving an increase over last year, placing an emphasis in digital, not to some extent the DDC, but overall in our digital business, which includes our wholesale business, I think is helping to create a little bit of momentum in that business. And then lastly, when we talked about the contact center business, We are seeing the benefit of the new customers that were added in the first quarter, and we're seeing traction there in terms of added seats, which we think will provide an incremental lift to the back half of the year.

So it sounds like you're seeing some evidence in this quarter, but you expect it to continue to build in Q4. Is that accurate?

Yeah, I think it would be a build between Q3 and Q4.

All right. And, you know, despite the declining revenue, you have been – you really haven't seen a huge drop in earnings, and you've generated significant cash flow. What's the plan for that cash right now? Is that all going to debt pay down?

Our focus is still primarily on bringing our debt levels down. As I mentioned, you know, our target is to get our net leverage ratio down into – somewhere between two and two and a half. We've been there historically, and we would like to get back into that position, which then would enable us to consider other uses of capital. So we're happy with the progress we've made in six months, but we've got unfinished business, and we'll remain focused on bringing those debt levels down.

And the last one for me, in the branded products business, it sounds like that has a lot of potential for you to grow if you can pick up some share there. What are the one or two things you need to do to pick up that share? Is it adding people? Is it increased promotional activity? What do you think the key is to growing share in that market?

Yeah, that's a great question. Growing share in that market means we have to take business away from one of our 22,000 competitors, right? The easiest way to do that is to take their salespeople who come to us with a book of business, and generally within 18 months have moved, you know, 80% of their book of business to us, and with the support we can give them, we can help them grow even, you know, double their business with us versus, you know, their prior employer. So that's the easiest and least expensive way. The second... most favorable way to do it is to really produce a marketing effort, which we have done very, very little marketing in the past. But we are starting to spend some money on marketing to drive people to us who perhaps have never heard from us before. And the third, probably the way we've done it in the past so successfully is we've bought some of our smaller competitors and rolled them up under Banco. And that's been a very successful strategy. Obviously, with our leverage ratio is where it's at right now. We're not comfortable doing that. We are talking to people. We continue to speak to them so that when things ease up from a covenant perspective, we'll be able to go ahead and actually close deals. I can tell you that You know, because of the way the economy is and because of the maybe interest rates being what they are and, you know, expectations being lower than they might have been a few years ago, I think the valuations will come in very, very well to our favor when we do go out and do acquisitions again. But in the meantime, we're sitting tight and trying to work through our capital requirements very, very carefully. But I would expect sometime next year that we will be back in M&A movement. I can't say we'll close any deals, but we certainly will be a lot more active. But there's never a shortage of opportunities out there. So those are really the three ways. Okay.

All right. Thank you.

The next question is from David Marsh with Singular Research. Please go ahead.

Hey, guys. Thanks for taking the questions. If I could start kind of at the macro, you know, the revenue guidance is a pretty meaningful reduction from what you guys provided last quarter. I guess the question is, do you feel like the numbers that you've put out are conservative enough that, you'll be able to hit that range here as we sit here kind of part of the way through the third quarter and really, you know, with only about five months left in the year.

Yeah, David, I would say, you know, we're comfortable with the range. You know, as we approached, got closer to the third quarter, a little bit into the third quarter, can get some sense of what's in the pipeline across our segments We felt that, you know, the range that we just got to do is a good range. We're certainly going to work very hard to not just meet that range but beat that range. But we feel like it's an appropriate range based on the trends that we've seen in the business more recently.

Okay. And then just turning to the inventory issue that you guys have talked about now for a little while. I mean, can you give us a sense of how close you feel like you are to kind of an equilibrium inventory level? I mean, is it still a long way to go or are you pretty close? I did appreciate the color provided there about being able to move some clearance through the website. That's really helpful to understand. But how, you know, are you pretty close to being at an equilibrium level where you can kind of get back to your normal purchasing?

We're definitely making progress, Dave. And as, you know, Michael alluded to on the digital space within healthcare, I think our emphasis on digital, both the DDC as well as our wholesale, has helped us to to liquidate some of the underperforming inventory, and we'll obviously continue to do that. As we talked about last year, when we were looking forward, we felt it was going to take the better part of the year for us to really reach what we would call our inventory equilibrium or our target. So I think the next two quarters will be critical. Obviously, we're expecting an improvement in the trend of the healthcare business, which will help us facilitate moving the inventory to reach our target. So the next two quarters will be important, and, you know, our goal is to reach our inventory equilibrium, you know, around the year-end period, and we'll remain focused on liquidating those inventories over the next two quarters.

And from a supply perspective, you haven't seen any meaningful disruptions, correct? You can still purchase at, you know, whatever kind of whatever level you would like to from your supply base. Is that a fair statement?

Yes. Yes, it is.

And then I just kind of reading, you know, I'm trying to read the tea leaves here. There was some kind of dancing around it, but I just wanted to get a definitive answer. As you sit here today with the performance metrics that you have, do you feel like you'll remain in compliance with the covenants or is it still, you know, kind of, you know, you still kind of feel like it's maybe 50-50 that you might need to do another amendment?

We feel comfortable with, you know, with the amendment that we have in place, you know, in our current standing in the business. So at this point, I would not anticipate, you know, any additional amendments that would be necessary. Obviously, we looked at this hard at the beginning of the year. It felt based on how we were viewing the cyclical nature of the business, we felt like it was appropriate to put an amendment in place that we felt would cover any potential increase in the ratio. Obviously, we've outperformed that, and so at this point, we feel comfortable as we move forward.

That's really helpful. Appreciate it. All right, let me yield the floor to another caller.

Seeing no further questions in the queue, I would like to go ahead and turn the call back to Michael Benstock for closing remarks.

Great. Thank you, Operator. Before we end this call, I would be remiss if I did not mention that we announced last month the passing of our Chairman Emeritus of the Board, my father, Jerry Benstock, whose vision and long career with Superior has spanned over 60 years and led to many of the successes we have enjoyed over the last many decades. Dad truly loved his Superior family and every community that we operated in and did much to tangibly improve the lives of so many. He'll be deeply missed by all who knew him. We mourn his loss. I want to thank all of you again today for joining our call. As you heard from us today, we continue to aim at profitably capturing share and creating long-term value for our shareholders, even as we continue to navigate these uncertain times. We're excited about the opportunities ahead, and we look forward to keeping you updated on our progress. Please don't hesitate to reach out with any questions, and I hope everyone enjoys the rest of this very hot summer. Thanks again.

The conference is now concluded. Thank you for your participation. You may now disconnect your line.