SGC Superior Group of Companies Inc

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and the notes thereto included in the Condensed Consolidated Financial Statements in Part I, Item 1 (“Financial Statements”) of this report and in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2022.

Cautionary Note Regarding Forward Looking Statements

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 may include, without limitation: (1) projections of revenue, income, and other items relating to our financial position and results of operations, including short term and long term plans for cash (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, (4) statements of expected industry and general economic trends and (5) the projected impact of the COVID-19 pandemic on our, our customers’, and our suppliers’ businesses.

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: the impact of competition; uncertainties related to supply disruptions, inflationary environment (including with respect to the cost of finished goods and raw materials and shipping costs), employment levels (including labor shortages) and general economic and political conditions in the areas of the world in which the Company operates or from which it sources its supplies or the areas of the United States of America (“U.S.” or “United States”) in which the Company’s customers are located; lingering effects of the COVID-19 pandemic, including existing and possible future variants, on the United States and global markets, our business, operations, customers, suppliers and employees, including the length and scope of restrictions imposed by various governments and organizations and the continuing success of efforts to deliver effective vaccines and boosters, among other factors; changes in the healthcare, retail, hotel, food service, transportation and other industries where uniforms and service apparel are worn; our ability to identify suitable acquisition targets, discover liabilities associated with such businesses during the diligence process, successfully integrate any acquired businesses, or successfully manage our expanding operations; the price and availability of cotton and other manufacturing materials; attracting and retaining senior management and key personnel; the effect of the Company’s material weakness in internal control over financial reporting; the Company’s ability to successfully remediate its material weakness in internal control over financial reporting and to maintain effective internal control over financial reporting; and other factors described in the Company’s filings with the Securities and Exchange Commission, including those described in the “Risk Factors” section herein and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. 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, except as may be required by law.

Recent Acquisitions

On May 1, 2022, the Company, through BAMKO, acquired substantially all of the assets of Guardian Products, Inc. (“Guardian”) of Norcross, Georgia. Guardian is a branded merchandise company that is one of the leading providers of promotional products to automotive dealers nationwide. The purchase price for the acquisition consisted of the following: (a) $11.1 million in cash, (b) the issuance of 116,550 restricted shares of Superior’s common stock (the “Guardian Stock”) that vest ratably over a three-year period, and (c) estimated potential future payments of approximately $2.3 million in additional contingent consideration based on the results of the acquired business through April 2025. The Guardian Stock is subject to transfer restrictions over the three-year period following the closing of the acquisition.

Business Outlook

Superior Group of Companies, Inc. (together with its subsidiaries, the “Company,” “Superior,” “we,” “our,” or “us”) is comprised of three reportable business segments: (1) Branded Products, (2) Healthcare Apparel and (3) Contact Centers. Beginning in the second quarter of 2022, the Company realigned its reportable segments to correspond with changes to its organizational responsibilities, management structure and operating model. Prior to implementing the current segment reporting, the Company’s Uniforms and Related Products segment included both healthcare apparel and uniforms. As part of the change in reportable segments, the branded portion of the uniforms business was combined with the previous Promotional Products segment to form the Branded Products segment, the healthcare apparel business became its own segment named Healthcare Apparel and income and expenses related to corporate functions that are not specifically attributable to an individual reportable segment are no longer presented in segment results. The previous Remote Staffing Solutions segment was renamed Contact Centers segment. All prior period segment information has been recast to reflect this change in reportable segments.

Branded Products

In our Branded Products segment, we produce and sell customized merchandising solutions, promotional products and branded uniform programs to our customers. As a strategic branding partner, we offer our customers customized branding solutions and strategies that generate favorable brand impressions, bolster customer retention and enhance employee engagement. Our products are sold to customers in a wide range of industries, including retail, hotel, food service, entertainment, technology, transportation and other industries. Sales volumes in this segment are impacted by a number of factors, including marketing programs of our customers and turnover of our customers’ employees, often times driven by the opening and closing of locations. From a long-term perspective, we believe that synergies within this segment will create opportunities to cross-sell products to new and existing customers.

Healthcare Apparel

In our Healthcare Apparel segment, we manufacture (through third parties or in our own facilities) and sell a wide range of healthcare apparel, such as scrubs, lab coats, protective apparel and patient gowns. We sell our brands of healthcare service apparel to healthcare laundries, dealers, distributors and retailers primarily in the United States. In 2021, the Company saw increased demand for healthcare service apparel from laundries, dealers, distributors, service hospitals and other medical facilities. However, as a result of the effects from the COVID-19 pandemic, the healthcare apparel market in 2022 was oversupplied creating a slowdown in demand. This softening of demand has continued thus far in 2023. In an effort to capture additional market share, in the first quarter of 2023 the Company launched a direct-to-consumer website and began rebranding its signature marketing brand WonderWink® to Wink™. From a long-term perspective, we expect that demand for our signature marketing brands, including Fashion Seal Healthcare® and Wink™, will continue to provide opportunities for growth and increased market share.

Contact Centers

This business segment (also known as “The Office Gurus”), which operates in El Salvador, Belize, Jamaica, Dominican Republic, and the United States, provides outsourced, nearshore business process outsourcing, contact and call-center support services to North American customers. These services are also provided internally to the Company’s other two operating segments. The Office Gurus has become an award-winning business process outsourcer offering inbound and outbound voice, email, text, chat and social media support. The nearshore call-center market has experienced a period of growth as businesses look to reduce operating costs while maintaining high-quality customer support. Nearshore operators are able to provide comparable service to their U.S. counterparts at a fraction of the price. With an environment and career path designed to attract and maintain top talent across all sites, we believe The Office Gurus is positioned well to continue growing this business.

Global Economic and Political Conditions

Economic and political events this year have altered the landscape in which we and other U.S. companies operate in a variety of ways. In response to inflationary pressures, the U.S. Federal Reserve has repeatedly raised interest rates, resulting in an increase in the cost of borrowing for us, our customers, our suppliers, and other companies relying on debt financing. It has indicated that it may raise rates further. World events, including the Russian invasion of Ukraine and the resulting economic sanctions, have impacted the global economy, including by exacerbating inflationary and other pressures. Prolonged inflationary conditions, high and/or increased interest rates, and additional sanctions or retaliatory measures related to the Russia-Ukraine crisis, or other situations, including deteriorating or prolonged diplomatic tension between the United States and China, could further negatively affect U.S. and international commerce and exacerbate or prolong the period of high energy prices. At this time, the extent and duration of these economic and political events and their effects on the economy and the Company are too difficult to predict.

Prolonged or recurring disruptions or instability in the United States and global economies, and how the world reacts to those disruptions or instability, could have long-term impacts on our business. These business impacts could negatively affect us in a number of ways, including, but not limited to, reduced demand for our core products and services, reductions to our revenue and profitability, costs associated with complying with new or amended laws and regulations affecting our business, declines in our stock price, reduced availability and less favorable terms of future borrowings, valuation of our pension obligations, reduced credit-worthiness of our customers, and potential impairment of the carrying value of indefinite-lived intangible assets.

Summary of Results

Net Income

The Company generated net income of $0.9 million during the three months ended March 31, 2023 and net income of $5.2 million during the three months ended March 31, 2022. The decrease in net income during the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was primarily due to decreases in Branded Products net sales and Healthcare Apparel net sales, an increase in Contact Centers selling and administrative expenses, and an increase in interest expense, partially offset by an decrease in income tax expense.

EBITDA

EBITDA (a non-GAAP financial measure) was $6.9 million and $10.0 million during the three months ended March 31, 2023 and 2022, respectively. EBITDA during the three months ended March 31, 2023 compared to the three months ended March 31, 2022 decreased primarily due to decreases in Branded Products net sales and Healthcare Apparel net sales and an increase in selling and administrative expenses, partially offset by an increase in Contact Centers net sales. For a reconciliation of EBITDA to net income, its most directly comparable financial measure calculated and presented in accordance with GAAP, please read “Non-GAAP Financial Measure” below.

Net sales for the Company decreased 8.9%, or $12.8 million, for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease was driven by declines in Branded Products and Healthcare Apparel, partially offset by an increase in Contact Centers.

Branded Products net sales decreased 15.7%, or $15.2 million, for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease was primarily due to decreased demand as a result of current market conditions that have tightened our customers’ advertising spending, the timing of new branded uniform rollout programs for certain customers and a decrease of $3.9 million in net sales of personal protective equipment driven by the easing of the COVID-19 pandemic. These decreases were partially offset by net sales of $6.5 million attributable to the acquisition of Guardian in May 2022.

Healthcare Apparel net sales decreased 7.9%, or $2.4 million, for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease was primarily due to a decrease in demand for healthcare apparel resulting from a continuation of challenging market conditions with saturated inventory levels post-COVID-19 pandemic.

Contact Centers net sales increased 22.7% before intersegment eliminations and 30.4% after intersegment eliminations for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. These increases were primarily attributed to onboarding of new customers during the last twelve months and providing expanded services to our existing customers.

Gross Margin

Gross margin rate for the Company was 36.0% for the three months ended March 31, 2023 and 34.7% for the three months ended March 31, 2022. The rate increase was primarily due to an improvement in gross margin rate for our Branded Products segment, the Company's largest segment, and the Contact Centers segment, our highest gross margin segment, representing a larger portion of total gross margin.

Gross margin rate for our Branded Products segment was 31.6% for the three months ended March 31, 2023 and 29.1% for the three months ended March 31, 2022. The rate increase was primarily driven by a favorable shift in the mix of pricing and customers.

Gross margin rate for our Healthcare Apparel segment was 35.9% for the three months ended March 31, 2023 and 39.3% for the three months ended March 31, 2022. The rate decrease was primarily driven by challenging market conditions and strategic efforts to right size inventory levels resulting in lower selling prices.

Gross margin rate for our Contact Centers segment was 53.5% for the three months ended March 31, 2023 and 59.4% for the three months ended March 31, 2022. The rate decrease was primarily due to increased employee related costs of our agents, partially offset by price increases.

Selling and Administrative Expenses

As a percentage of net sales, total selling and administrative expenses was 33.2% for the three months ended March 31, 2023 and 29.4% for the three months ended March 31, 2022. The selling and administrative expense rate increased across all segments.

As a percentage of net sales, selling and administrative expenses for our Branded Products segment was 24.5% for the three months ended March 31, 2023 and 22.2% for the three months ended March 31, 2022. The rate increase was primarily due to expense deleverage on the 15.7% decrease in sales, partially offset by lower selling and administrative expenses resulting from a decrease in expense of $0.8 million which resulted from the remeasurement of acquisition contingent liabilities and a decrease in sales commission expense.

As a percentage of net sales, selling and administrative expenses for our Healthcare Apparel segment was 33.8% for the three months ended March 31, 2023 and 33.0% for the three months ended March 31, 2022. The rate increase was primarily due to expense deleverage on the 7.9% decrease in sales, partially offset by lower selling and administrative expenses resulting from a decrease in employee related expenses, including sales commissions.

As a percentage of net sales, selling and administrative expenses for our Contact Centers segment was 43.8% for the three months ended March 31, 2023 and 35.5% for the three months ended March 31, 2022. The percentage increase was primarily attributed to increased investment in organizational infrastructure, including personnel, to support future growth of this segment.

Interest Expense

Interest expense increased to $2.6 million for the three months ended March 31, 2023 from $0.3 million for three months ended March 31, 2022. This increase was primarily due to an increase in interest rates on our outstanding borrowings. The weighted average interest rate on our outstanding borrowings for the three months ended March 31, 2023 was 6.6% compared to 0.9% for the three months ended March 31, 2022.

Income Taxes

Income tax expense for the three months ended March 31, 2023 compared to the three months ended March 31, 2022 decreased by $1.5 million. The decrease in income tax expense was driven by a decrease in pre-tax income. The effective income tax rate was 6.0% and 22.4% for the three months ended March 31, 2023 and 2022, respectively. The effective tax rate for the three months ended March 31, 2023 was favorably impacted by discrete non-taxable gains on the Company’s written put option and income generated on the Company’s SERP totaling $0.4 million and $0.2 million, respectively. The effective tax rate may vary from quarter to quarter due to discrete, unusual or non-recurring items, the resolution of income tax audits, changes in tax laws, the tax impact from employee share-based payments, or other items.

Liquidity and Capital Resources

Overview
 
Management uses a number of standards in measuring the Company’s liquidity, such as: working capital, profitability ratios, cash flows from operating activities, and activity ratios. The Company’s balance sheet generally provides the ability to pursue acquisitions, invest in new product lines and technologies and invest in additional working capital as necessary.

The Company’s primary source of liquidity has been its net income and the use of credit facilities and term loans as described further below. In the future, the Company may continue to use credit facilities and other secured and unsecured borrowings as a source of liquidity. The Company may also begin relying on the issuance of equity or debt securities, including under its universal shelf registration statement (File No. 333-249760), to the extent available. There can be no assurance that any such financings would be available to us on reasonable terms. Any future issuances of equity securities or securities convertible into or exercisable for equity securities may be dilutive to our shareholders. Additionally, the cost of the Company’s future sources of liquidity may differ from the costs of the Company’s sources of liquidity to date.

Working Capital

Superior carries inventories of both raw materials and finished products, the practice of which requires substantial working capital, which we believe to be common in the industry.

Cash and cash equivalents increased by $8.9 million to $26.6 million as of March 31, 2023 from $17.7 million on December 31, 2022. Working capital decreased to $220.6 million at March 31, 2023 from $232.8 million at December 31, 2022. The decrease in working capital was primarily due to a decrease in accounts receivable, an increase in accounts payable, a decrease in other accounts receivable and a decrease in inventory, partially offset by an increase in cash and cash equivalents and a decrease in other current liabilities. The decreases in accounts receivable and other accounts receivables were primarily driven by decreased sales for the quarter within our Branded Products segment and the collection of customer payments, including credit card payments. 

Material Short-Term Plans for Cash

For the remainder of the year 2023, our primary capital requirements are to maintain our operations, meet contractual obligations, fund capital expenditures, pay dividends and for other general corporate purposes. We currently anticipate that we will spend less in capital expenditures in 2023 than we spent in 2022. Management currently believes that the combination of our current cash level, cash flows provided by operating activities and availability under the revolving credit facility will be sufficient to satisfy the above requirements for the next twelve months.

Material Long-Term Plans for Cash

Beyond the next twelve months, our principal demand for funds will be for maintenance of our core business, to satisfy long term contractual obligations and the continuation of the Company’s ongoing capital expenditure program designed to improve the effectiveness and capabilities of its facilities and technology. The Company at all times evaluates its capital expenditure program in light of prevailing economic conditions. The Company’s material contractual obligations include outstanding debt, operating leases, acquisition-related contingent liabilities, unfunded supplemental executive retirement plan liabilities and non-qualified deferred compensation plan liabilities. In the first quarter of 2023, the Company’s Branded Products segment entered into a new long-term lease for a warehouse in Phoenix, Arizona with total estimated rental payments of $7.4 million. This new lease is part of management’s plan to consolidate warehousing facilities related to promotional products inventory. Management currently believes that the combination of our current cash level, cash flows provided by operating activities and availability under the revolving credit facility will be sufficient to satisfy the above requirements. 

Operating Activities. The increase in net cash provided by operating activities during the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was primarily attributable to decreases in cash outflows for inventory and accounts payable and an increase in cash inflows from accounts receivable, partially offset by an increase in cash outflows for selling and administrative expenses, a decrease in net sales and an increase in interest paid. Working capital cash changes during the three months ended March 31, 2023 included a decrease of $10.2 million in accounts receivable. Working capital cash changes during the three months ended March 31, 2022 included an increase of $8.7 million in inventory and a decrease of $5.7 million in accounts payable and other current liabilities.

Investing Activities. The decrease in net cash used in investing activities during the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was attributable to a decrease in capital expenditures in the current period as compared to the prior year period. 

Financing Activities. The increase in net cash used in financing activities during the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was primarily attributable to $11.9 million in net repayments of debt in the current period compared to $13.9 million of net borrowings of debt in the prior year period. Excess cash generated from operating activities during the three months ended March 31, 2023 was used to repay outstanding borrowings under the revolving credit facility.

Credit Facilities (See Note 3 to the Financial Statements)

On August 23, 2022, the Company entered into a Credit Agreement (the “Credit Agreement”) among the Company, the domestic subsidiaries of the Company, as guarantors, the lenders party thereto (the “Lenders”), and PNC Bank, National Association, as administrative agent for the Lenders (the “Administrative Agent”), pursuant to which the Lenders are providing the Company senior secured credit facilities maturing in August 2027 consisting of a revolving credit facility in the aggregate maximum principal amount of $125.0 million and a term loan in the original aggregate principal amount of $75.0 million (collectively, the “Credit Facilities”), and the ability to request incremental revolving credit or term loan facilities in an aggregate amount of up to an additional $75.0 million, subject to obtaining additional lender commitments and satisfying certain other conditions. 

As of March 31, 2023, the Company had $144.2 million in outstanding borrowings under its Credit Facilities, consisting of $72.0 million outstanding under the revolving credit facility and $72.2 million outstanding under a term loan.  As of March 31, 2023, the Company had undrawn capacity of $53.0 million under the revolving credit facility.

Obligations outstanding under the Credit Facilities accrue interest at a variable rate equal to the secured overnight financing rate (“SOFR”) plus an adjustment of between 0.10% and 0.25% (depending on the applicable interest period) plus a margin of between 1.0% and 2.0% (depending on the Company’s net leverage ratio). During the covenant relief period described in Note 12 to the Financial Statements, the applicable margin may reach 2.5% for SOFR rate loans. The weighted average interest rate on our outstanding borrowings under the Credit Facilities was 6.6% at March 31, 2023. During the term of the revolving credit facility, the Company will pay a commitment fee on the unused portion of the revolving credit facility equal to between 0.125% and 0.250% (depending on the Company’s net leverage ratio). During the covenant relief period, the commitment fee may reach 0.300%. The available balance under the revolving credit facility is reduced by outstanding letters of credit. As of March 31, 2023, there were no outstanding letters of credit under the revolving credit facility.

Contractual principal payments for the term loan are as follows: remainder of 2023 - $2.8 million; 2024 - $4.7 million; 2025 - $5.6 million; 2026 - $6.6 million and 2027 - $52.5 million. The term loan does not contain pre-payment penalties.

The Credit Facilities are secured by substantially all of the operating assets of the Company, and the Company’s obligations under the Credit Facilities are guaranteed by all of its domestic subsidiaries. The Company’s obligations under the Credit Facilities are subject to acceleration upon the occurrence of an event of default as defined in the Credit Agreement. The Credit Agreement contains customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, restricted payments (including dividends and related distributions), liquidations, mergers, consolidations or acquisitions, affiliate transactions and sales of assets or subsidiaries. The Credit Agreement also requires the Company to comply with a fixed charge coverage ratio of at least 1.25 to 1.0 and a net leverage ratio not to exceed 4.0 to 1.0, except during the covenant relief period. The Company’s net leverage ratio (as defined in the Credit Agreement) is generally calculated as the ratio of (a) indebtedness minus unrestricted cash to (b) consolidated EBITDA for the four most recently ended fiscal quarters. As of March 31, 2023, the Company was in compliance with these ratios as the Company’s fixed charge coverage and net leverage ratios were 1.5 to 1.0 and 3.8 to 1.0, respectively. 

On May 4, 2023, the Company and its domestic subsidiaries entered into a First Amendment to Credit Agreement with the Administrative Agent and the lenders, which (i) provides a covenant relief period through December 31, 2023, which the Company may opt to terminate during the fourth quarter of 2023 if it has a consolidated total net leverage ratio at or below 4.00 to 1.0 for the two preceding consecutive fiscal quarters; (ii) permits a maximum consolidated total net leverage ratio of 4.5 to 1, 4.8 to 1, 4.5 to 1 and 4.0 to 1 for the first, second, third and fourth quarters 2023, respectively; (iii) amends the applicable margin pricing grid to add a tier of applicable margins (2.5% for SOFR rate loans) if the consolidated total net leverage ratio is greater than 4.0 to 1, which tier would only apply during the covenant relief period; (iv) prohibits capital expenditures during the covenant relief period that exceed $10 million, with additional limitations imposed on a quarterly basis; (v) prohibits acquisitions and incremental loans during the covenant relief period; (vi) adds sale and leaseback transactions to the list of transactions that require the Company to use the net proceeds thereof to make a mandatory prepayment under the Credit Agreement; (vii) limits restricted payments to $20 million in any fiscal year, and no more than $10 million during the covenant relief period, with additional limitations imposed on a quarterly basis during the covenant relief period; and (viii) lowers the amount of permissible investments in non-loan party subsidiaries to $5 million during the covenant relief period.

Dividends and Share Repurchase Program
 
During the three months ended March 31, 2023 and 2022, the Company paid cash dividends of $2.3 million and $1.9 million, respectively. The Company anticipates that it will continue to pay dividends in the future as financial conditions permit.

 
On May 2, 2019, the Company’s Board of Directors approved a stock repurchase program of up to 750,000 shares of the Company’s outstanding common stock. There is no expiration date or other restriction governing the period over which the Company can make share repurchases under the program. All purchases under this program will be open market transactions. At March 31, 2023, the Company’s remaining repurchase capacity under its common stock repurchase program was 657,451 shares. Shares purchased under the common stock repurchase program are constructively retired and returned to unissued status. The Company considers several factors in determining when to make share repurchases, including among other things, the cost of equity, the after-tax cost of borrowing, the debt to total capitalization targets and its expected future cash needs.

Non-GAAP Financial Measure

EBITDA, which is a non-GAAP financial measure, is defined as net income excluding interest expense, income tax expense and depreciation and amortization expense. The Company believes EBITDA is an important measure of operating performance because it allows management, investors and others to evaluate and compare the Company’s core operating results from period to period by removing (i) the impact of the Company’s capital structure (interest expense from outstanding debt), (ii) tax consequences and (iii) asset base (depreciation and amortization). The Company uses EBITDA internally to monitor operating results and to evaluate the performance of its business. In addition, the compensation committee has used EBITDA in evaluating certain components of executive compensation, including performance-based annual incentive programs.

EBITDA is not a measure of financial performance under GAAP and should not be considered in isolation or as an alternative to net income, cash flows from operating activities or any other measure determined in accordance with GAAP. The items excluded to calculate EBITDA are significant components in understanding and assessing the Company’s results of operations. The presentation of the Company’s EBITDA may change from time to time, including as a result of changed business conditions, new accounting pronouncements or otherwise. If the presentation changes, the Company undertakes to disclose any change between periods and the reasons underlying that change. The Company’s EBITDA may not be comparable to a similarly titled measure of another company because other entities may not calculate EBITDA in the same manner.

The following table reconciles net income to EBITDA (in thousands):