Superior Group of Companies, Inc. (SGC) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon, everyone. And welcome to the Superior Uniform Group’s Third Quarter 2015 Conference Call. With us today are Michael Benstock, the Company’s Chief Executive Officer and Andy Demott, its Chief Operating Officer, CFO and Treasurer. After the speakers’ opening remarks, there will be a Q&A session. [Operator Instructions] This call is being recorded and your participation implies consent to this. If you do not agree, simply drop off the line. I will now like to turn the call over to Hala Elsherbini, Senior Vice President of Halliburton Investor Relations who will read the Safe Harbor statement. Please go ahead, Ma’am.

Thank you. This conference call may contain forward-looking statements about Superior Uniform Group’s business opportunities and its anticipated results of operations. Please bear in mind that forward-looking information is subject to risks and uncertainties and actual results may differ from what you hear today. Many of these risks and uncertainties are described in Superior Uniform Group’s Annual Report on Form 10-K for fiscal 2014 in this morning’s news release and the company’s other filings with the SEC. Forward-looking statements in this conference call are based on our current expectations and beliefs. Management does not undertake any duty to update the forward-looking statements made during this conference call or elsewhere. Please note that all growth comparisons that management makes today will relate to the corresponding period of last year unless otherwise noted. With that, I will turn the call over to Michael.

Thank you, Hala and good afternoon everyone. It’s a pleasure to have you here to talk about our performance for the third quarter and nine months which ended on September 30, 2015. I will start with some highlights of our financial and operational performance, plus some comments on industry trends. After this Andy will give you additional background on our financial progress. Then I’ll return with a general outlook for the rest of the year. After this, we’ll both be happy to answer any of your questions. We are pleased with the results for the third quarter. It was a good quarter, which met our expectations, what isn’t readily apparent is all the progress we made on continuing to execute our growth plans to improve our future performance. We experienced our 12th consecutive quarterly increase in net sales which were up 8.4%. Uniforms and related products saw a sales rise of 6.2%, this reflected a stronger economy than a year ago which our customers tell us also led to slightly higher rates of employee turnover. In addition, we increased our market penetration during the quarter and continue to gain market share, however pricing remains competitive, but generally it is still rational. Our employee I.D. business through a Superior I.D. and HPI Direct is strong. Our retail partners are currently at peak hiring levels as they prepare for the holiday selling season and we are filling many uniform orders early in the fourth quarter that will be followed by the typical slowdown in orders as our customers shift their focus to selling their own products before yearend. The Office Gurus net sales jumped 60.8% through solid market penetration with new and existing customers. Because this is a fast growing but small portion of total revenues, I’d like to reiterate our rationale behind this strategic extension of our business. We started the segment to provide back office support for our uniform business when unemployment levels in our area were below 3% and we found ourselves unable to hire entry level employees. The initial goal was to give our customers a better experience, in fact not only were we able to service our customers more effectively we are able to also significantly reduce our operating expenses. By the end of 2009, we began operating this solution to other companies. The Office Gurus target customer bases broad, we don’t compete with larger call center providers which are constantly being pressured for lower rates from their large customers, instead our niche focus is on the smaller customers which typically need to start with fewer seats generally less than 25 and engagement even can start with as few as three or four seats and then increase overtime as we broaden our service scope and handle multiple functions, such as inbound product support goals, outbound product sales and lead generation for those customers. Ultimately though our goal is to become an extension of our customers operations rather than just providing commoditized work. We handle so many aspects of their business over the long term that we develop a very deep relationship. We essentially help our customers grow their businesses long term. So it’s not surprising that the increase in net sales we saw last quarter came from both new and existing customers. From a bottom line perspective, a powerful combination and factors led us to increase net income by 19.7% for the quarter. This included our successful efforts to control SG&A which continues to expand at a far lower rate than sales. We also reduced our interest expense and saw a lower effective tax rate. Andy will detail this further in his financial review While this is good news, what really makes the quarter standout in my mind are the three actions we took to improve our growth prospects. Firstly, as we stated on earlier calls, we have a keen focus on the direct healthcare market and during the quarter our Uniform and related products division Fashion Seal Healthcare signed its second contract this year with another healthcare group purchasing organization where as you know now known as a GPO for short. The second GPO goes into effect in November 1st and coupled with a premier GPO which was awarded earlier in the year we now have access to nearly 5000 facilities. Let me provide some additional background on our GPO strategy. The largest GPOs control the most number of hospital beds in the country and we are speaking to all of them, not only the ones we have under contract. We are engaging in direct conversations with GPO member executives raising their awareness and understanding of our value proposition. For some this is a relatively new value proposition as GPO contracts had not offered a uniform category in the past. Purchasing has been inconsistent and fragmented within these healthcare groups. By creating a uniform category, GPOs can now offer members optimized pricing in a more efficient purchasing process. This includes more than giving these companies a better price. They now have the ability to create a consistent, branded quality look for themselves that not only raises employee satisfaction which is important as turnover increases it also can make a better impression on the patients that they serve. And patient satisfaction standards are getting -- are gaining greater attention through the hospital consumer assessment of healthcare providers and systems initiative and [Indiscernible] refer to them in the future as HCAHPS. These national standardized patient satisfaction surveys are being administered to collect information and publicly report patient perspectives on care and quality related activities. This enables hospital comparisons to support consumer choices. Hospitals will now receive a 1 to 5 star rating visible to the public. This rating along with survey scores incentivizes hospitals to improve their overall patient experience. Being able to properly identify hospital staff members through uniforms is one distinct way to add to patient satisfaction and thereby improve HCAP ratings. Also, it is important to note that the concept of uniform categories as I said is new to many healthcare groups and we aggressively are marketing this more streamlined approach to uniform purchasing. While this is a slow process, we are gaining traction. We are implementing test programs and our efforts are yielding solid opportunities, and as we stated in the past, we expect this to become a significant part of our business in the next three to five years. Secondly, we are opening our first company managed manufacturing facility in almost 15 years. We’ve entered into a long term agreement to lease a factory being built to our specifications [Indiscernible] industrial park. We recognized that making certain products in the duty free Haiti environment gives us the best long-term value proposition in our hemisphere. It offers a combination of an inexpensive workforce and duty free shipments into the U.S. using imported fabrics. The factory opened in January ramped up to about 150 employees within 9 months. Further growth beyond that will happen as we achieve our initial efficiency goals. We believe that once the factory is up to full speed, no one will be able to offer customers a better, cost and service value proposition on the uniforms that we make there. This will give us a major competitive advantage and it is the lowest cost option for us to operate around factory. We are very, very excited about this opportunity and its future prospects. Thirdly, we are progressing with our call center capacity expansions in addition to smaller renovations and believes and the U.S. we are opening our new facility in El Salvador in mid 2016, which is a few months later than originally planned though that should be in time for our needs. This will when completed double our existing capacity. We are taking these actions to stay ahead of what we know is significant demand. While this is a sizeable capital investment to increase our capacity, this segment does not require us to spend heavily on an ongoing basis to generate sales. We have a small sales force and limited trade shows. Additionally the sales cycle for this business is typically less than six months compared to the two to three years it could take to acquire a major uniform customer. And as you can see our net sales continue their steep growth curve each quarter, in addition once the facility is in place our ongoing costs are relatively low and yield a great return on the investments. Since our growth is affected by what’s happening in the economy and all of our business segments, let’s look at current trends. New jobs, new hires and employee turnover are all positive indicators for our business. The significant inflection point that we saw in job growth during 2014 was moderated, but stabilized at a good pace in 2015. Recent reports though indicate some deceleration in jobs and economic growth in the last couple of months, additionally there is a general level of uncertainty distraction around Presidential election cycles that normally begins during the fourth quarter before an election year, however we had yet to see any significant impact from these factors but we are watchful. Stats from the U.S. Department of labor show most employment indicators in August continue near historical levels; however total job openings decreased to 5.4 million in August after reaching a series high of 5.7 million in July. The greatest number of job openings occurred in two of the markets to support our growth, healthcare and retail trade. At the end of August healthcare job openings increased 12.5% from what we saw a year ago. In addition, hiring was 16.8% higher and separations rose 10.8% over the last year. Retail trade job openings increased by 6.1% for the same period. Hiring grew 10.2% and separations were 8.3% higher than a year ago. My point in recapping these numbers to you is to emphasize that we do see our customers increasing employment overall and they are also telling us that the turnover percentages are continuing to rise. And while employment in the markets we serve has improved over the last year, we balance this with cautionary note that the recovery remained sluggish. We will continue to manage. Our business tightly and expect a solid finish to this year. Move people will need uniforms as total employment in the markets we serves grows and as turnover increases of course. Our customers also are spending more on branding initiatives. This extends beyond uniforms and into promotional products which we offer through our value added brand and merchandise division Blue Fusion. Customers also appreciate the one-stop shopping experience we offer, which help them to round up their corporate identity programs. We continue to strengthen our promotional products market position as we pursue accretive acquisitions to broaden our footprint. With this background, I'll turn the call over to Andy to give you more detail on our three and nine-month performance.

Thank you, Michael, and good afternoon everyone. Let’s start with the third quarter income statement. Net sales increased 8.4% to $56.7 million. Our uniforms and related products contributed 6% of this gain with remote staffing solutions adding the remaining 2.4%. As Michael mentioned, uniforms and related product sales grew 6.2% from last year's third quarter. This reflects increased market penetration, high employee turnover and a solid new business pipeline. The remote staffing solutions segment saw quarterly sales for outside customers rise 60.8% from a year ago. The increase came from a good mix of business from new and current customers. In addition, we are attracting more business in our U.S. call center. Cost of goods sold rose about 10.6% to $37.4 million. As a percent of sales, cost of goods sold was 66.1% compared with 64.8% in 2014. The difference came from higher direct product cost as a percentage of net sales primarily due to new business that carried a lower gross margin than our average account. This new business however also requires lower level of customer service, distribution and other related cost reflected in lower selling and administration cost. As I mentioned earlier, we also attracted higher volume of domestic business in our remote staffing solutions segment that generates higher hourly billing rates than offshore services, but the gross margin percentage earn is lower. Gross margins at the percentage of sales was down to 33.9% or $19.2 million. For the 2014 third quarter it was 35.2% or$18.4 million. Our gross margin fluctuate mainly based on customer mix and the level of service required. As discussed earlier, some of our uniform contracts carry a higher gross margin, but also require a higher service component. Other contracts have low touch and have lower gross margins. However, these accounts can be just as profitable if not more so than contracts with higher gross margins. As I mentioned before a portion of our growth came from new business with one of our large customers who initiated a made in the USA Uniform program. This program is at a higher average dollar selling price, but carries a lower margin percentage than our average customer. Due to the size of the contracts and higher domestic volume overall operating margin did not accelerate at the same level and came in essentially flat compared to the 2014 third quarter. This business certainly makes the significant contribution and we are proud to take on this type of program. As we indicated, we manage to the net margin and we follow a rigorous activity based quality model that we built over the years. That's why we believe looking at operating margins offers a better measure of our overall profitability as oppose to gross margin. Our selling, general and administrative expenses increased 3% in the latest quarter to 13.5 million. As a percentage of net sales, SG&A drop to 23.8% for the third quarter compared to 25.1% last year. This trends shows how we're leverage our fixed cost structure across the higher level of sales as well as the impact to the lower touch program I covered in the discussions on gross margins. Interest expense decrease 9.7% from this quarter last year to $130,000 primarily because of our average borrowings outstanding being lower. Income from operations expanded by 7.5% to $5.7 million, and led to an operating margin of 10.1% versus 10.2% for the three months in 2014, our effective tax rate decline to 22.8% from 34.8% for last year's three-month period. The decrease came primarily from an increase in the tax benefit on income from foreign operations, a low state rate because the stats limitation expired on some of our uncertain tax positions and the reversal of deferred tax on income from foreign operations that is now considered to be permanently reinvested. Net income for the quarter was $4 million, up 19.7% from this time last year. On a diluted per share basis third quarter earnings per share were $0.28 versus $0.24 last year, a 16.7% increase. This occurred despite of 4.2% increase in diluted shares outstanding. Now, for a recap of our income statement for the year to-date period, net sales grew 7.2% to $157.1 million. Uniforms and related product sales expanded by 5.4%, organic growth in the current year more than offset of $5 million new uniform rollout and $2.5 million special promotional program that we saw in the second quarter of last year. Remote staffing solutions revenues to outside customers experienced 50.5% growth. Cost of goods sold increased 9% to $103.6 million. This represented 65.9% of sales compared with 64.9% for the nine months last year. The increase is largely due to higher direct product cost prior to the absence of the large $5 million rollout not above, which carried a higher gross margin than our average account. In addition to the substantial new business, I mentioned earlier in the review of the results of the third quarter which also carries a lower gross margin percentage. SG&A expenses continue to increase at a lower rate in sales, rising only 1.9% from the year ago to $39 million. As a percentage of sales SG&A dropped to 24.8 % compared with 26.1% for the year ago period. Interest expense rose 12.2% to $395,000. This indicates the higher interest rate that was paid on some of our long-term debt as part of an interest rate swap agreement that went into effect at the beginning of the third quarter of 2014. Operating income grew 10% to $14.6 million. That gave us an operating margin of 8.3% compared with 9.1% for last year's nine months, our effective tax rate drop to 31.7% from 34.2% a year ago. Net income for the year to-date expanded 14.2% to $9.7 million and diluted earnings per share increased 8% to $0.67 versus $0.62 a year ago on 6.1% more diluted shares outstanding. We continue to return value to our shareholders in the form of quarterly dividend. In August, we increase quarterly dividend by 10% to more than 0.08 per share. For the year to-date we have paid cash dividends of $3.1 million versus $2.7 million in the first nine months of last year. Let's move on to the balance sheet, our financial condition remains very strong. Our cash and cash equivalents decreased 30% so far this year to $3.1 million. Much of this was used upon our new facilities in El Salvador and Haiti. Accounts receivable grew 25.4% to $35.1 million reflecting higher sales in the third quarter of 2015 in comparison to the fourth quarter of 2014. Inventories increased 6.9% to $62.3 million to support those sales volumes. This also led to a 59.7% increase in accounts payable to $15.5 million. Long-term debt was 6.8% lower at $21.1 million as we continue to pay down debt. Shareholders equity expanded 13.3% to $91.1 million. Cash flows from operating activities were $5.6 million so far this year versus a $4.1 million at this time in 2014. As you would expect, this year’s spending is focusing on property, plant and equipment as we continue to build out the new facilities in El Salvador and Haiti. Overall, we are pleased with our three and nine-month performance. Now, I will turn the call back to Michael, so he can share a general outlook for the company.

Thanks Andy. Operationally we're meeting our growth milestones and managing our business tightly to response the changing market and economic conditions. We expect to finish the years as anticipated and we remained confident in our long term revenue goals. As a reminder, over the next three or five years we expect to increase uniform revenues in average of 6% annually and the entire company by an average of 8% per year or greater. Here are two numbers that help, put this in perspective. According to last year's census data reports, the uniform industry has grown 4% annually since 1986 versus a 2.6% annually U.S. GDP growth rate during the same time period. While the data lags one year, historically the uniform industry has outpaced GDP growth and we were on track to grow faster than the uniform industry in general. We expect to make process on organic in all areas of our business during the fourth quarter. In addition, we're actively pursuing acquisitions and now are in discussions with the number of candidates. We stepped up our strategic approach to identify and attract charter companies that meet our specific criteria. Our benchmarks that companies that can give us critical mass in existing new market create new relationships for us or at products and services that are logical extension of our business. With that, I think this would be a good time to begin taking questions.

We will now begin the question and answer session. [Operator Instructions] And our first question comes from Kevin Steinke of Barrington Research. Please go ahead.

Good afternoon, everyone. Wanted to ask about the second GPO, when that you announced and congratulations on that. Just wondering, as you get your message out there of your value proposition to healthcare organizations, if there is kind of a network effect in winning these GPO awards that is once you win one, is the second easier and so on and so forth. Or I just wondering if that's the case and if you think your message is really starting to take hold in that particular market?

Great question. The first one took us couple of years to get, so certainly the second one has been easier than we've been working on all of them during that period of time. They have certain timeframes that they actually open these categories up or that they create new category. So we've been talking to the five largest GPOs and even more than that, but let's talk about the top five that control most of the hospital beds in this country. We've been talking to them for a couple of years. And you're absolutely right, after getting the first one there tense to be a lot more opportunity to open the other ones up sooner. We have created the value proposition for the GPOs, they see a revenue stream that they haven't really enjoyed from this category before And they also say the opportunity be involve with the mission of the hospital to help, improve their age gap scores and help improve branding and imaging and so on. So we're having no trouble discussing the message wherever we are in this country. We have teams of people out today, for instance in the Midwest talking with the major hospital system as we have single week and people are shaking their head. It’s kind of a revelation to them, why didn't they consider that spend before, but when they realize how fragment it’s been within their healthcare system the spending, and they pulled the numbers together and they see how substantial it is. They also understand that there's an opportunity for savings. So, it's been resonating very, very well.

Okay, great. You mentioned in your opening comments continuing to take market share, but the pricing environment is still competitive. Could you just review how you’re going about taking market share in a still competitive pricing environment and the value proposition that enables you to take market share in that type of environment?

The value proposition allows us to take market share. We offer something that most of our competition doesn't, and that's a really stellar design team work very closely to make sure that we align the uniform program with the customers marketing and imaging and all of their advertising that they’re doing. They were in line within the core of their different locations, and that we give their customers a really great experience and that could be their employees and their customers, great experience by providing great uniforms. One of things we do is we – maybe because of our manufacturing back on original routes has a really strong manufacturing company back in a day and we had 14 factories in the United States. And we had a strong sourcing department who understood the products very well. We still actually have that. So we have feed on the ground in many of the countries, most of the countries where we operate. We have a fabric sourcing group that is second and none. We have a laboratories that we manage to make sure that every lot of good that we order is what was originally spec and will be eventually when put into use will behave like its suppose to. And I think the other things, social compliance certainly, is extremely important to our customers. And they know how forward thinking we are with respect to social compliance. I think part of what it comes down to as you know we've been around a long time. They know we're financially strong certainly for the larger program they look at us. We're transparent, we're public. They can see our financials. They know that they're dealing with the company that has financial where with all support them. We stand behind their products 100%. We have a process that we go through of problem resolution and mitigation that I think is second and none. And we've reduced the errors in credits that we have to give our company down to an in phantasmal [ph] amount for an apparel company which was -- what we are in that instance when it comes to supplying garments to people. It's quite extraordinary. So I think there's a lot of different. We support our customers by helping them with their marketing and on the creative side, with our own marketing efforts and we've done that with some customers. So I believe the one thing that distinguishes us more so, we putting everything aside is our service. We've been done this long time. We've run our own factories. We don't rely – I'm a highly skeptical person, so I guess everybody works will be now, so when we are dealing with suppliers, we trust but validate and we make sure that everything that we tell our customers that we can backup with actually happening in the field. So I think that pretty well sums it up.

Okay. Thanks for that color. And just you mentioned looking to make acquisitions. How would you characterize the environment is out there looking, is it pretty competitive or do you feel like your well positioned – more well positioned then others to get deals done or is it something where you're going to have to be real patient and wait for kind of the right price and the right opportunity.

It's probably all that Kevin. I wouldn't say, its competitive, we don't see other a lot of other companies like us trying to rollup other companies, trying to rollup smaller competitors or identify other competitors. And I have to tell you that it’s not that we haven't look at companies that we thought on the face of it we'd like to buy, but after looking at the companies we've decided that we don't want to buy them. We're looking for great talent when we buy a company. We're looking for people who can add value to our overall organization. I mean, not that we wouldn't buy a company, shut it down, roll it all in, if that was the right move, we've done that in the past. But I'd much rather find a company of entrepreneurs and people who still have fire in the belly and want to grow the hack out of their businesses like the HPI Direct people did. So identifying and finding those types of companies is little harder than just finding a smaller company. You're dealing any smaller company. You're dealing with people who generally built the business, started the business themselves, built and grew it, have strong attachment to their business and some of them are just not ready to sell. They will be – they will come a point in time where they will want the liquidity event and they might be wanted to be part of the larger organizations or will need to capitalize in some way and we may be able to offer them that. But we're being patient, but we're working on it. I can tell you very, very diligently to move things forward. But we're not going to step into an acquisition that's not exactly right for us.

Okay. That's make sense. Well, thanks for taking my questions and for updating us on your progress. So, I appreciate it.

Great. Thank you.

[Operator Instructions] And our next question comes from Gary Steins [ph] a Private Investor. Please go ahead.

Good afternoon, gentlemen. I was curious if you could speak a little bit more about the effective tax rate and what is it something abnormalized rate that we should expect because if you normalize the current quarter and year to-date results like around 35% rate, the EPS growth rate has been muted quite a better especially in other way we have shares outstanding, can you talk to that please?

Yes. I think if you look at the rate, I mean, obviously the third quarter rate is the time of year where –with the timing and when we when we file tax returns, that’s when the statutes and limitations kick in, so that did have an impact of a couple of points in the quarter. I think the more normalized rate is back around that 34% or so ongoing 34%, 35% on an ongoing basis.

Okay. And I guess we are in the roughly second year in a row where our free cash flows are not covering the dividend DC that working capital efforts will be able to bring us into a higher free cash flow levels we have comforted the cash dividend discovered.

Yes I think -- during the first stage I mean we are at a higher capital expenditure period right now. We’re building the call center in El Salvador as well the Haiti factory. I mean that’s a short term thing that will be completed mid next year. On the other side our working capital generation we’ve been in a very low interest environment. We maintain a little bit higher inventories than we really absolutely have to have right now. The cost of curing, it isn’t that much and it provides us the ability to service our customers at a much better level. If we had need to, we could put the screws to that and squeeze out a fair amount of that to recover, we’re not in the kind of crunch.

Okay, good. And I’m just curious as to how much from a high level do you believe that your facilities are underutilized, so let’s say next week you hit the lottery in all your sales people are bringing in more orders that you’ve ever had before, how much could you reasonably assume if you were to get a huge jump in orders without adding more capacity? It occurred to me that the guys are underutilized right now.

I would say that to a degree or so. It really depends on where that lottery comes from? Right, right if it’s high touch items or its not high touch items meaning if it’s high touch items they will be at higher prices. I would -- as an investor I would not worry about superior having capacity. Our capacity is somewhat flexible and expandable, most of what you are referring to is capacity to house inventory and chip inventory and certainly that’s somewhat elastic. We have the ability to expand well beyond where we are right now. And in our call center business clearly by mid next year we’ll have the ability to spend as far as we like for a few years there won’t be any concerns, but if there are concerns we can accelerate that as well. We’ve never let our capacity ever get in our way of our growth. And we won’t in the future either.

Okay. Good, thanks gentlemen.

Thank you.

At this time there appears to be no further questions. I would like to turn the conference back over to management for any closing remarks.

Thank you very much. As you can see there was good news in the third quarter. We did more than meet our expectations for this period. We laid the ground work for continued organic growth of opportunities and we continue to pursue accretive acquisitions. We are steadfastly focused on maintaining a strong capital structure and delivering sustainable shareholder returns. And then I really appreciate your time today. We look forward to sharing our fourth quarter and year-end results with you next February. Until then we wish you a good end to your end and a strong start in 2016.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.