Superior Group of Companies, Inc. (SGC) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, everyone. Welcome to Superior Uniform Group's 2017 Third Quarter Earnings Conference Call. With us today are Michael Benstock, the Company's Chief Executive Officer; and Andy Demott, its Chief Operating Officer and CFO. [Operator Instructions]. This call is being recorded, and your participation implies that you agree to this. If you don't, then simply drop off the line. Now I will turn the call over to Hala Elsherbini, Vice President of Halliburton Investor Relations, who will read the safe harbor statement. Please go ahead.

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 2016 and 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 make today will relate to the corresponding period in 2016 unless otherwise noted. With that, I'll turn the call over to Michael.

Thank you, Hala, and good afternoon, everyone. Welcome to our third quarter 2017 earnings call. As usual, I'll review highlights of our Q3 results and provide thoughts on the market trends underlying our operating environment. Andy will then provide more detail on our financial performance, then I'll wrap up with some closing remarks and we'll be happy to take your questions. Overall, we are pleased to report another quarter of solid profitability with an 11.6% increase in net income. Net sales grew 3.8%. This marked our 20th consecutive quarter of increasing year-over-year revenue. During the third quarter, we delivered significant top line growth at 2 of our business segments, partially offset by a net sales decline of 6.3% in our uniform segment. Before reviewing the factors that impacted our third quarter results, I would like to point out that we continue to deliver solid earnings growth at a rate greater than that of our sales increases through our broadened product and service offerings and streamlined operations as well as the strength of our sourcing capabilities across our expanded scale. Andy will provide additional detail on his financial review, but we are pleased to see nice improvement in gross margins, which, in turn, led to a very strong operating margin of 10.4%. Our segments' performance during the quarter also validates our strategy of diversification into businesses that provide the potential for solid growth and profitability and are not influenced equally by the same market dynamics. From a sales perspective, our uniform segment's quarterly results were somewhat impacted by the significant hurricane activity as some of our customers focused more on their own business recovery than they did on placing uniform orders. We were able to mostly mitigate the impact in our own operations. However, customers impacted by the storms delayed some orders and shipments. Additionally, some of our contractors in Haiti were adversely affected by the hurricanes, and our own Haiti factory experienced a very short temporary shutdown but thankfully reported no damage. The Fabelli factory in Haiti, our factory, continues to ramp up and is already within reach of our goal of nearly 300 employees. Puerto Rico experienced much more hurricane damage, but our contractors' factories miraculously only sustained a long power outage that has just been restored. Our contractors' facilities are now operating, though thus far, only about 85 of the - percent of the employees have actually returned. There's been a little bit of a hiccup, but our reliable strategy of redundant manufacturing has enabled us to manage through our network with minimal disruption to our customers. In addition, as a result of the uncertainty of the retail market, we have also seen customers announce a freeze on hiring additional temporary seasonal workers for this upcoming holiday season. This reduced the seasonal uptick we generally see beginning late in the third quarter and usually completed by early fourth quarter. Overall, though, our product lines continue to perform well, particularly in the health - direct health care channel. Fashion Seal Healthcare carries solid brand equity with an especially strong presence servicing laundries and distributors. While it is a mature market with intense competition, we are positioned well as pricing gets aggressive, taking advantage of our scale and sourcing power. And our diversification into the other direct health care markets, such as medical colleges, is proving successful. In our employee I.D. markets, we continue to benefit from the collective strengths of Superior I.D. and HPI Direct as they move to complete the integration as one customer-facing entity. Our operational and administrative shared services group is integral to this process, further enabling us to reduce costs, realize efficiencies and capitalize on the scale of our combined businesses to strengthen our market position. In our Promotional Products segment, we mentioned last quarter that we expected BAMKO to return to strong, double-digit growth in the third quarter. In fact, BAMKO bounced back with nearly 74% growth in net sales in the third quarter. Of that growth, 66% is organic, with the balance coming from our recently completed acquisition of Public Identity. While Public Identity's size is relatively small, it is a good strategic fit with a leading position in the collegiate licensing space. We continue to work through a robust acquisition pipeline, taking a managed approach as we integrate Public Identity, implement enhanced sales strategies for them and execute further acquisitions. The Office Gurus, our call center segment, delivered an excellent third quarter, reporting a 37.1% increase in net sales. We are moving aggressively to broaden our footprint to keep pace with higher-than-anticipated growth in this underserved market niche. We're seeing the benefits of our new sales efforts that are producing solid opportunities. Our employee count has nearly doubled at our new El Salvador building to more than 800 associates, and it is likely we will end the year with nearly 1,000. As we discussed on prior calls, our agents service not only external customers' back and front office needs but also now support all of our other divisions, thereby enhancing the value proposition to our customers and the companies we acquire. Of note, we're also seeing additional business opportunities from cross-selling efforts across all divisions, including The Office Gurus. It's a win-win strategy. Turning to what we are seeing on a macro level. As I mentioned earlier, in our uniform segment, the market is quite competitive with commodity prices [indiscernible] abroad as foreign currencies have strengthened against the dollar. Also, with the Chinese government demanding a higher level of environmental compliance, we are seeing more and more textile mills closing and the cost of chemicals that produce dyes and fabrics increasing. This is beginning to drive prices higher on nearly all fabric types. To mitigate effects on our operations, we're taking longer positions, extending contract terms and putting more efforts into our sourcing efforts to make sure that we are capping our costs as much as possible. There is also still political uncertainty around the different trade agreements. We are less tied to NAFTA, as we all have heard about, but we are monitoring CAFTA and agreements that do affect us in Haiti. We believe we have adequate agility and risk management measures in place to continue our record of profitable growth no matter. While the slump we have seen recently in the uniform business appears to be impacting the industry as a whole following several strong years, our current U.S. economic and political environment, albeit uncertain and somewhat confusing, continues to see moderate improvement in the employee metrics that we monitor. Now I'll turn the call over to Andy to give you more detail on our third quarter financial performance.

Thank you, Michael, and good afternoon, everyone. We filed our Form 10-Q for the third quarter ended September 30, 2017, this morning, so I'll limit my review to key income statement highlights for the quarter and 9-month period. As Michael noted, third quarter 2017 net sales increased 3.8% to $67.8 million. Sales growth softened during the quarter, but we are seeing a significantly larger opportunity pipeline than last year. For segment contribution, Remote Staffing Solutions contributed 2.1% and Promotional Products contributed 7%, with overall gains partially offset by a decline of 5.3% contributed by the uniform segment. On a year-over-year basis, net sales decreased 6.3% in our uniform segment. And as we discussed last quarter, in 2016, one of our large customers was acquired by a competitor, which was serviced by different uniform provider. While we were successful on our efforts to maintain a portion of this customer's business, the impact of the transition on sales in the third quarter was an additional reduction in net sales of approximately $2 million. Additionally, as Michael stated, a succession of hurricanes delayed some shipments in the quarter. While it is difficult to determine exactly what was hurricane related, we can specifically identify over $2 million in programs that would have delivered in the third quarter. These were pushed into the fourth quarter of 2017 at our customers' request. In Remote Staffing Solutions, quarterly sales to outside customers increased by 37.1% from a year ago as growth accelerated through a combination of new customer engagements and further penetrating our existing customer base. Our Promotional Products segment sales increased by a very impressive 73.9%. The increase was primarily due to new customer acquisitions and expanded programs with existing customers. In addition, the Public Identity acquisition in August contributed 7.7% to the growth. As we have indicated on prior calls, the nature of this business line and the variations in the size of client projects can cause variability in sales from quarter-to-quarter. Clearly another highlight of our quarter is our margin expansion. Consolidated margins increased to 36.6% compared to 35.4% in the year-ago period. Our margin performance speaks to our strong execution and success we've had gained in economies of scale across our segments. We continue to focus on our operating margins, which does reflect a better measure of our overall profitability due to gross margin fluctuations that can occur from customer mix. SG&A expenses increased 4.6% in the latest quarter to $17.7 million. As a percentage of net sales, SG&A was relatively flat at 26.2% compared to 26% in 2016 third quarter. Income from operations increased to $6.8 million, which led to an operating margin of 10.4% versus 9.5% in Q3 of 2016. Our effective tax rate for the quarter was 27.5% versus 26% last year. The increase came from a decrease in the benefit related to tax credits and an increase in state tax rate, partially offset by an increase in the benefit of foreign-sourced income. We delivered solid bottom line results as third quarter net income rose 11.6% to $5 million or $0.33 per diluted share compared to net income of $4.4 million or $0.30 per diluted share. Let's shift for a quick review of our 9-month results. Net sales increased 3.4% to $194.4 million, with higher sales driven by our BAMKO and Public Identity acquisitions as well as significant growth in our remote staffing segment. Uniforms declined by 3.1% for the 9-month period due to several factors we've already outlined but largely due to the loss of the large customer discussed earlier. The net impact - net sales impact from this customer was a total of $4 million, which includes the partial offset from the sale of their remaining inventory commitment in the second quarter. Promotional Products' net sales increased 44.1% for the 2017 9-month period compared to the 2016 period, inclusive of the BAMKO acquisition. This included 2 additional months of sales in 2017, contributed 32.2%, and our August 2017 acquisition contributing 2.4%, with the balance coming from organic growth. Remote Staffing Solutions revenues to outside customers expanded by 24.6%. As a percentage of net sales, our consolidated SG&A expenses for the first 9 months of 2017 increased to 27.2% compared to 26.8% in the year-ago period. Of note, included in Promotional Products segment SG&A expenses for the 2016 9-month period was approximately $1.1 million of acquisition-related expenses. As previously noted, we sold our original call center location in El Salvador in the first quarter of this year. The sale generated net proceeds of approximately $2.8 million and resulted in a pretax gain of approximately $1 million. Operating income increased 20.5% to $17.5 million, and operating margin was very strong at 9% compared to 7.7% in the 2016 period. Excluding acquisition-related expenses for the 2016 period, our operating margin would have been 8.3%. Our financial condition remains very healthy, supported by free cash flow and ample liquidity to fund our future growth. We have a keen focus on maintaining a solid balance sheet, and our current cash position substantially increased to $13.3 million. We continue to return value to our shareholders in the form of a quarterly dividend, and during the first 9 months, we paid cash dividends of $3.9 million, an increase of 11.1%. We are well fortified with our capital structure as we continue to execute against our long-term growth plan. I'll now turn the call back to Michael for his closing remarks and a general outlook for the remainder of the year.

Thanks, Andy. Our third quarter results reflect the consistent high-level execution of our teams as well as our success in converting diversified top line growth, extended scale and operating efficiencies into meaningful bottom line results. Although consolidated revenue growth was modest and gives us some headwind towards achieving our average annual revenue growth target of 8%, we take a long-term approach to our business prospects and our long-term outlook remains very positive. We're executing against our acquisition strategy to supplement our long-term growth objectives, and we plan to update our 3- to 5-year long-term growth goals during our 2017 fourth quarter and year-end report. We operate in proven business sectors that will offer distinct opportunities at various times. The range of businesses we have built for our company provides the ability to manage the performance and grow through a strategic investment. We will continue to channel our resources into the segments and markets where they will provide the greatest returns for our company and our shareholders. Before I wrap up and open for questions, I want to take this opportunity to announce that Kirby Sims, the Founder and President of the company's HPI Direct division, will be retiring effective December 31, 2017. Kirby's outstanding leadership and entrepreneurial vision made HPI Direct a market leader in our industry. When we joined forces in 2013, we were confident that HPI's stellar customer-centric team and strong client base, combined with our financial strength and vast resources, would make for a very successful partnership. That has proven true. We appreciate Kirby's service, his outstanding leadership and the dynamic, sustainable organization that has very much complemented our offering to potential and existing customers. We have already put in place an experienced industry veteran, John-Sable, who will be taking Kirby's position, and he has already been working with Kirby over the last couple of months on business integration strategies and acquisitions. We're hoping to keep Kirby engaged and working with us from time to time. We have the utmost admiration for him and value the partnership we've enjoyed over the years. We look forward to continuing that, even if on an intermittent basis. And as always, the success of our near-term and long-term growth strategies is built upon the dedication and drive of our associates to enhance our customer experience, our operational excellence, our products, our competitive position and our shareholders' values. We thank them for their continued commitment and hard work. At this time, we'd like to open this up for questions.

[Operator Instructions]. Our first question will come from Kevin Steinke of Barrington Research.

So, I'll start off by just asking about the disruption from the hurricanes on your customers. As far as you can tell, are your customers back to, I guess, operating as normal as possible in that particular situation as we move into the fourth quarter and maybe we'll see a more normal flow of business out of them?

Our customers in Florida certainly are, for the most part. I don't think Houston is back to 100%. And Puerto Rico certainly isn't. We have customers in Puerto Rico as well. While not a large portion of our customers, we still do have a percentage of our customers there. I will not, in fourth quarter, be talking about the hurricane anymore. It will - and whatever impact it will have, we believe, will be quite insignificant.

Okay, that's helpful. And you did reference the legislative environment again a bit there. Are you still seeing some of that uncertainty in decision-making among customer due to the political environment? Or do you think that's maybe falling a little bit? Any updated thoughts there?

I think there's political confusion in Washington, and that's creating confusion among the masses. Nobody knows what's going to happen to tax law and how that's going to impact them. That is affecting some people's purchasing, waiting to see when is the best time to buy, when is the best time to make an investment in new programs, when's the - what's going to happen with minimum wages, although that seems to be flushing out and states seem to be doing their own thing right now. But - and then what's going to happen to trade legislation certainly. I mean, I don't see in the near term - in the near term, our government is going to take on NAFTA. They said they're going to do that, and I believe they're going to do that. There are those who believe that there'll be some trade-offs between that and our immigration policy. But after they get through that, they said they're going to take on CAFTA. Well, it might take them 1 year or 2 to take NAFTA before they start taking on the Central American Free Trade Agreement. And 2 of the Haiti agreements would probably be the last thing they would go after, which is the HELP agreement and the HOPE II agreement. So, I think we have a couple years till we see the impact of Washington moving in any direction, but I think the uncertainty is definitely out there, where goods are being made right now, customers making decisions that are long-term decisions, not knowing what's going to happen with tax laws and minimum wage. Amazon is a factor, Kevin. A lot of retailers right now are very concerned of how Amazon and online ordering will affect their businesses. And so, while we're not in the business of consumer markets, so to speak, a lot of our customers are. And they engage a lot of employees who wear uniforms, and they believe they're going to be impacted. So, they're all trying to redefine themselves. And as they try to redefine themselves, they're not necessarily focused on redesigning a new uniform program. Well, they still have to clothe the people that they have, and they're still having the turnover that they're having, which is ever increasing. And so, while it's a good thing that turnover's increasing because if they're not hiring for seasonal workers like they normally do this time of year, at least they're having, for our benefit, higher turnover, which is resulting in just as many uniforms sold.

Okay, that's helpful. And following up on that retail freeze you mentioned, should we think about that as a meaningful impact on the fourth quarter? Or is it, like you said, turnover is mostly offsetting that? I don't know how that would balance out.

Yes, well, you have to remember we protect ourselves to a large extent by those kinds of events happening at retail by being - having so many different segments that we serve. So, it couldn't provide some retail and it could be a couple percent on retail. But then again, you've got transportation and you've got hospitality and you've got food service. And you've got so many other places where we do business that I don't think I'll be able to enumerate to you at the end of fourth quarter. Perhaps I'll be able to say there was an impact. I believe there will be. It'll be small. But we'll be helped a little bit by the deferrals that we had from third quarter to fourth quarter that we spoke about due to the hurricane. And not everybody is having a hiring freeze. Although some of the largest players are, I've said they're not hiring seasonal workers this year, and they're going to give their employees the benefit of being able to work overtime if they'd like to and try to lessen the impact that those employees have felt themselves from some of the hurricane happenings.

Okay. Yes, that makes sense. In terms of the impact from the lost customer you've talked about the last couple quarters here, should we think of a similar impact to revenue in the fourth quarter with that roughly $2 million rate?

Their total revenues in the fourth quarter last year were $2 million. I mean, as we've said, we are still doing a small portion of business. So, $2 million would be the upper end of what it could impact you.

Okay, got it. And I thought the gross margin performance was impressive in the quarter, particularly in the uniform segment. Despite the fact that you had a revenue decline there, still operating margin of - I'm sorry, I'm sorry, gross margin of 35.9% in the uniform segment. You referenced economies of scales, but was there any program mix there that benefited that margin? Or what caused it to be so strong in the quarter?

I think it really was generated more by the sourcing efforts that we've put in over the last several years, where we're reaping the full benefits of that at this point with the scale of having the combination of us and HPI and even BAMKO, who are the people who we're able to put on the ground through their organization over there. I think all those things have really generated lower cost. I'm sure there's a small portion of it. It might be mix. You see our SG&A percentage is a little higher this year, but that's a minor piece of it.

Yes, and think about it this way, Kevin. We have sitting on the shelf now roughly 5.5 months of inventory in our pipeline, I should say. And that's already bought and - for the most part and at a fixed price that is producing that margin that you're seeing. And we're buying now for that following 6 months, right. We're in the process of buying out for the next 6 months. And we've been locked in those same prices and not seeing any price pressures, although I'm sure we'll see some. But from a customer standpoint, the margins are pretty solid, I would say, for the next 6 to 12 months. I mean, there could be a variation up or down a couple of tenths. But what we're going to see from then on, which would be really 2019, is you're going to see a lot more price pressure on the upside with textile the most. And a lot of it has to do with this Chinese compliance. It is driving prices up as well as oil and everything else and freight costs going up. And so, I - that is not always a bad thing, seeing a little inflation. We're an industry - the apparel industry, if you look at us on that side of it, is an industry that doesn't often get opportunities to raise its prices. So, we actually could see some of that. As long as we stay ahead it, we'll benefit by it. I think we've got good plans in place to do so.

Okay, yes. And again, talking about those rising fabric prices, it sounds like that's something you're already planning for. I mean, as you look back at the history of the company, does this jump out as something particularly unusual or meaningful or just something that you feel like you can manage through and continue as pretty steady state as you move forward?

Yes. If you recall some 7, 8 years ago, we had the cotton crisis, and then that was unusual. That was a totally unusual event where prices just absolutely skyrocketed to levels nobody had ever seen before. And the availability of cotton became very, very tight. We're not seeing that kind of environment. We're going to see some pricing increases, but there shouldn't be irrational increases. And we should be able to get rational increases on the contracts we have and make sure the timing is such that we get them at the same time that we're actually having to pay more for some of those. I don't see this as a highly unusual event, although it's been - we've been in a - for - on the fabric side for the last few years, we've been in a pretty stable environment. Prices have initially gone down, but they haven't gone up either. And at we - as we gain scale, we've had the ability to leverage that and get better prices than we were able to get before. Just by the mere fact we could give a factory more orders now, we've been able to give them more orders than we were before. So, we'll continue to use that scale to try to leverage our strength to keep our cap on what the increases are.

Okay. And then just switching over to the Promotional Products. You did the acquisition of Public Identity, I think, the first of these tuck-ins that you're targeting. So, can you just talk about what attracted you to that particular business and then, I guess, the health of the overall pipeline there?

Yes. Let me talk about the - how we view the pipeline first and then we'll talk about Public Identity, if you don't mind. So, when we look for companies, we're looking for companies that bring us something we don't already have. Either they bring us a geographical space that we're not currently strong in, they bring us a market segment that we really had no penetration in, a channel that we're just not selling into. And what could those channels be? It could be financial service companies or movie producing studios or - and on the battle of drink companies, soda companies. There are so many different places that companies out there have strengths and that we might not have the strength or the expertise on how to approach it. So, we'll look at those and say, is this a geographically centric company that basically has built a certain mass - good market, a strength of following, good branding and so on? That would be good for us. And so that just extends what BAMKO already is. And then there's those that - who have a certain niche, who not only bring to themselves a focus into a certain niche but then give BAMKO and the other companies BAMKO acquires the ability to be better at going after that kind of niche. They become the experts and they help BAMKO do it. And then there's a third kind of company that has an expertise in a product that BAMKO might not have an expertise in. I'll give you an example of that. The Promotional Products business is a very expanded business, and this is an area I'm particularly interested in. But the whole printing of point-of-sale or printing posters or printing materials for a - is considered actually part of the promotional business. And it's a very interesting segment. It's one that BAMKO has some expertise in but certainly isn't the biggest expert out there. There are companies that do it a lot better than they do. So, using that - or somebody that does skins on trucks and cars, advertising skins on trucks and cars, that's a certain type - there are types of companies that are - do that, do that very well as well as other promo products, but that may be a niche that they have. Well, they could bring that expertise, and then they would be interesting to us because we want to be a full-service promotional products company. We're going to look very much like a marketing agency by the time it's done because we're going to be able to do almost everything from a promotional standpoint customers would want us to. We'll be a true partner in helping them elevate their brand. And so that's what we're looking for. What Public Identity had, albeit quite a small company with $6 million in revenue that we see going forward immediately, and, of course, we're going to build on that with great opportunities with the licenses they have collegiately already that they - we don't feel they fully capitalized on, but by using our model of sales, which we've learned through our Office Gurus group, we feel we can escalate their sales quite dramatically over the next few years and make them a much bigger player in the collegiate space. And so, they weren't so interesting for the $6 million or the collegiate space, they were interesting because we feel we can take that $6 million and make it a much larger number.

Right, okay. Yes, that makes sense. And just on The Office Gurus, I believe in your prepared comments you said you're also seeing opportunities to cross-sell there. Did I get that right? Or - and are you then looking to cross-sell that to uniform customers, Promotional Products, et cetera?

It's actually - The Office Gurus is actually - refer to them - their clients to BAMKO, and that has resulted in business. And BAMKO has referred clients to The Office Gurus that were speaking to now, so that could result in business.

[Operator Instructions]. And at this time, there appears to be no further questions. I would like to turn the conference back over to Michael Benstock for any closing comments.

Thank you very much. Andy and I appreciate all of your time today, and we look forward to updating you on our year-end results in February. See you then.

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