Superior of : SGC 2Q23 Earnings Call Transcript

Second Quarter 2023 Earnings Conference Call

August 7, 2023

CORPORATE PARTICIPANTS

Michael L. Benstock: Chief Executive Officer & Director, Superior Group of Cos., Inc.

Michael Koempel: Chief Financial Officer, Superior Group of Cos., Inc.

OTHER PARTICIPANTS

Kevin Mark Steinke: Analyst, Barrington Research Associates, Inc.

James Sidoti: Analyst, Sidoti & Co. LLC

David P. Marsh Analyst, Singular Research

Operator: 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 Koempel, 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.

Michael L. Benstock

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 noncash 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 through 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% 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've been able to drive 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 and 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 of $3.3 million reflecting a margin of 14%, slightly improved from the first quarter. Relative to adjusted EBITDA of $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-teens.

I'll now turn the call over to Mike before we take Q&A. Mike?

Michael Koempel

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 continued to expect a backend-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%, up 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 cost 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 head count 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 noncash impairment charges related to goodwill and trade names of $30 million or $28 million net 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 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 requirement.

Turning to our updated full-year outlook. Given the persistence of soft and uncertain macroeconomic conditions, we now expect a revenue range of $550 million 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 backend- 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.

Operator: Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Kevin Steinke with Barrington Research. Please, go ahead.

Kevin Mark Steinke

Analyst, Barrington Research Associates, Inc.

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

Michael L. Benstock

Yeah. Kevin, hi. Thanks for the question and I'll jump in. Mike can add anything that he sees.

We have started to see some positive signs for budgets opening up and marketing spend in the past few months. 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 30 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 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 some budgets are opening up, some budgets aren't, but 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 our targets are realistic for the second half of the year. Still, second half of the year, if you 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 it's really a mixed bag, it truly is.

We're seeing 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 more part of our Branded Products segment today. And then you look at Healthcare was up, in fact, second quarter, but there's still a lot of products in the marketplace that's being sold by our competitors.

I have no visibility to how much excess product they have left to sell, and those are just coming down significantly. We're looking to get past our issue of any kind of product overhang by the end of this year, which I think we've been pretty clear on. And lastly, when we get to the call center business, 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?

Michael Koempel

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 Centers 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 cut back 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 the customers in the pipeline. So, we feel good about the back-half of the year for Contact Centers.

Kevin Mark Steinke

Great. Thank you for all the insight there. 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 an amendment to your credit agreement you had executed. So, how should we think about leverage and cash flow as we look to the second half of the year and relative to the covenants you have in place for the remainder of this year?

Michael Koempel

Sure, yeah. Kevin, I'll say 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 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, I would say, modest improvement balance of the year. And obviously, with the improvement that we have 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 2.5 or lower. That will take some time but we're, obviously, feeling more positive as we move forward.