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, 2019.

Disclosure 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) the projected impact of the current coronavirus (COVID-19) on our, our customers’, and our suppliers’ businesses, (2) projections of revenue, income, and other items relating to our financial position and results of operations, (3) statements of our plans, objectives, strategies, goals and intentions, (4) statements regarding the capabilities, capacities, market position and expected development of our business operations, and (5) statements of expected industry and general economic trends.

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; the effect of uncertainties related to the current coronavirus (COVID-19) pandemic on the U.S. and global markets, our business, operations, customers, suppliers and employees, including without limitation the length and scope of the restrictions imposed by various governments and success of efforts to find a suitable vaccine, among other factors; general economic conditions, including employment levels, in the areas of the United States of America (“United States”) in which the Company’s customers are located; changes in the healthcare, retail, hotels, food service, transportation and other industries where uniforms and service apparel are worn; our ability to identify suitable acquisition targets, successfully integrate any acquired businesses, successfully manage our expanding operations, or discover liabilities associated with such business during the diligence process; the price and availability of cotton and other manufacturing materials; attracting and retaining senior management and key personnel and other factors described in the Company’s filings with the Securities and Exchange Commission, including those described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. 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.

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) Uniforms and Related Products, (2) Remote Staffing Solutions, and (3) Promotional Products.

COVID-19 Impact

The COVID-19 pandemic continues to affect our operations and financial performance, and likely will continue to do so for an undetermined period of time. While during the three months ended March 31, 2020, the pandemic did not have a material impact on the Company’s business, international, federal, state and local efforts to contain the spread of COVID-19 intensified in March 2020 as governments enacted shelter in place orders, declared states of emergency, took steps to restrict travel, enacted temporary closures of non-essential businesses and took other restrictive measures that prohibit many employees from going to work. These government measures have begun to lead to changes in customer purchasing patterns and supply chains.

COVID-19 could continue to have a number of increasingly adverse impacts on our business, including, but not limited to, additional disruption to the economy and our customers’ willingness and/or ability to spend, temporary or permanent closures of businesses that consume our products and services, additional work restrictions, and supply chains being interrupted, slowed, or rendered inoperable.  Our employees and the employees and contractors of our suppliers and customers also could become ill, quarantined, or otherwise unable to work or travel due to health reasons or governmental restrictions.

The majority of the principal fabrics used in the manufacture of products within the Uniform and Related Products segment are sourced in China and the vast majority of raw materials used in our Promotional Products segment are predominantly sourced from China, either directly by BAMKO or its suppliers. If we are unable to continue to obtain affordable raw materials and finished products from China or if our suppliers are unable to source affordable raw materials from China, it could significantly disrupt our business. A prolonged pandemic, or the threat thereof, could significantly disrupt our product sourcing, which in turn, could significantly disrupt our business.

We have and will continue to monitor and control our expense levels to protect our profitability. For example, on March 30, 2020, we entered into debt deferment agreements with Truist Bank (formerly known as Branch Banking and Trust Company) to: (i) defer contractual principal and interest payments due between April 1, 2020 and June 1, 2020 under the 2017 Term Loan and 2018 Term Loan until their respective maturity dates; and (ii) defer contractual interest payments due between April 1, 2020 and June 1, 2020 under the revolving credit facility until its maturity date. Additionally, we are proactively taking steps to increase available cash on hand by targeted reductions in discretionary operating expenses. Finally, we are delaying certain capital expenditures relating to non-essential projects until economic conditions begin to stabilize.

Prolonged instability in the United States and global economies, and how the world reacts to them, 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 products and services, reductions to our revenue and profitability, costs associated with complying with new or amended laws and regulations affecting our business, further declines in our stock price, reduced availability and less favorable terms of future borrowings, valuation of our pension assets and obligations, reduced credit-worthiness of our customers, and potential impairment of the carrying value of goodwill or other indefinite-lived intangible assets. The extent to which the COVID-19 pandemic impacts our business, financial condition, results of operations or cash flows will depend on numerous evolving factors that we are unable to accurately predict at this time. The length and scope of the restrictions imposed by various governments and success of efforts to find a suitable vaccine, among other factors, will determine the ultimate severity of the COVID-19 impact on our business. However, it is likely that prolonged periods of difficult market conditions would have material adverse impacts on our business, financial condition, results of operations and cash flows.

Uniforms and Related Products

In our Uniforms and Related Products segment, we manufacture and sell a wide range of uniforms, career apparel and accessories. Our primary products are service apparel, such as scrubs, lab coats, protective apparel and patient gowns, provided to workers in the healthcare industry, and service apparel, such as uniforms, provided to workers employed by our customers in various industries, including retail, hotels, food service, transportation and other industries. We sell our brands of healthcare service apparel primarily to healthcare laundries, dealers, distributors and retailers. As a result of the COVID-19 pandemic, we anticipate increased sales of our healthcare service apparel to laundries, dealers and distributors that service hospitals and other medical facilities; however, sales of healthcare apparel to retail markets may be negatively impacted. We are currently working with our retailers to develop alternative strategies to ensure that our customers are able to take advantage of the increase in demand from medical professionals. From a long-term perspective, we expect that demand for our signature marketing brands, including Fashion Seal Healthcare® and WonderWink®, will provide opportunities for growth and increased market share. Sales of uniforms are impacted by our customers’ opening and closing of locations and reductions, increases, and turnover of employees. The current economic environment in the United States has been significantly impacted by the COVID-19 pandemic, and as a result, we expect to see reduced short-term demand for uniform apparel in many of our customers’ industries, some of which is expected to be offset by demand from customers in certain retail industries, such as grocery and pharmacy customers, and healthcare. Based on the longer-term fundamentals of our uniform business, we anticipate that we will have growth opportunities when market conditions in the United States stabilize and begin to improve. 

Remote Staffing Solutions

This business segment (also known as “The Office Gurus”), which operates in El Salvador, Belize, Jamaica, and the United States, initially started to support the Company’s back office needs while improving overall efficiencies and lowering operating costs. After years of consistently improving key performance indicators, lowering costs and providing exceptional service to our Uniforms and Related Products segment in areas such as order entry, cash collections, vendor payables processing, customer service, sales, and others, The Office Gurus started selling their services to outside companies in 2009. Over the past 10 years, The Office Gurus has become an award-winning global business process outsourcer offering inbound and outbound voice, email, text, chat and social media support. The COVID-19 pandemic has created certain disruptions in our ability provide services to our customers, and has resulted in a reduction in billable hours charged to our customers. The pandemic has also generated uncertainties for our customers and their industries. With an environment and career path designed to attract and maintain top talent across all sites, The Office Gurus is positioned well to continue growth when market conditions begin to stabilize. 

Promotional Products

For more than a decade, we sold promotional products on a limited basis to our existing Uniforms and Related Products customer base. While there were substantial opportunities to sell promotional products to those customers, it was not an area of focus, specialization, or expertise for us. On March 1, 2016, that changed with our acquisition of substantially all of the assets of BAMKO, Inc. (“BAMKO”). One of the top firms in the promotional products industry, BAMKO has a number of strengths, well-developed systems, and time-tested processes that offer significant competitive advantages. With a robust back-office support platform operated out of India, direct-to-factory sourcing operations based in China, and proprietary technological platforms and programming capabilities that we believe are very competitive, BAMKO is positioned to be a platform for potential future acquisitions in this industry. We completed two additional acquisitions in this segment in late 2017 and remain open to additional acquisitions going forward. In recent years we have seen an increase in customer orders and expect those growth opportunities to continue once the current market environment stabilizes. As a result of the COVID-19 pandemic, however, the branded merchandise industry has experienced customer budget cuts and widespread event cancellations that has led to customer orders being delayed or cancelled entirely. Our Promotional Products segment is experiencing reduced activities from customers in certain areas, such as the restaurant and entertainment industries. In responding to the needs of our customers, the sourcing team within the Promotional Products segment has recently focused on the sourcing of much needed personal protective equipment for our customers to help offset the shortfall in sales from our existing product lines. From a long-term perspective, we believe that this segment’s synergistic fit with our uniform business will create opportunities to cross-sell the products of various business segments to new and existing customers. 

Net sales for the Company increased 8.9% from $86.6 million for the three months ended March 31, 2019 to $94.2 million for the three months ended March 31, 2020. The principal components of this aggregate increase in net sales were as follows: (1) an increase in the net sales of our Uniform and Related Products segment (contributing 1.6%, of which $2.0 million (contributing 2.3%) represented the effect of differences in timing of revenues recognized under ASC 606 between periods), (2) an increase in the net sales for our Promotional Products segment (contributing 6.7%), and (3) an increase in net sales for our Remote Staffing Solutions segment after intersegment eliminations (contributing 0.6%).

Uniforms and Related Products net sales increased 2.4%, or $1.4 million, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The increase was primarily due to the timing of finished goods receipts for inventory items with no alternative use. Shipments by our Uniform and Related Products segment decreased from $60.4 million to $59.8 million comparing the three months ended March 31, 2020 with the prior year period. For a reconciliation of shipments by our Uniform and Related Products segment, see “Shipments (Non-GAAP Financial Measure)” below.

Remote Staffing Solutions net sales increased 7.0% before intersegment eliminations and 6.0% after intersegment eliminations for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. These increases were primarily attributed to providing continued services in the current year period to our customer base that was expanded during 2019. Despite the increase in net sales, overall growth during three months ended March 31, 2020 was negatively impacted by disruptions in March 2020 resulting from COVID-19.

Promotional Products net sales increased 28.6% or $5.8 million, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The increase was primarily due to the expansion of our sales force in 2019 and continued product sales to our expanded customer base during the current year period.

Cost of Goods Sold

Cost of goods sold consists primarily of direct costs of acquiring inventory, including cost of merchandise, inbound freight charges, purchasing costs, and inspection costs for our Uniforms and Related Products and Promotional Products segments. Cost of goods sold for our Remote Staffing Solutions segment includes salaries and payroll related benefits for agents. The Company includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with out-bound freight are recorded in cost of goods sold. Other shipping and handling costs are included in selling and administrative expenses.

As a percentage of net sales, cost of goods sold for our Uniforms and Related Products segment was 64.3% for the three months ended March 31, 2020 and 65.4% for the three months ended March 31, 2019. As a percentage of net sales, cost of goods sold remained relatively flat. The increase in cost of goods sold during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to the revenue increase explained above.

As a percentage of net sales, cost of goods sold for our Remote Staffing Solutions segment was 43.3% for the three months ended March 31, 2020 and 41.4% for the three months ended March 31, 2019. The percentage increase was primarily driven by disruptions in March 2020 resulting from COVID-19.

As a percentage of net sales, cost of goods sold for our Promotional Products segment was 71.0% for the three months ended March 31, 2020 and 72.4% for the three months ended March 31, 2019. The percentage decrease was primarily the result of differences in the mix of products and customers, with sales to higher margin contract customers representing a larger percentage of our overall sales during the three months ended March 31, 2020.

Selling and Administrative Expenses

Selling and administrative expenses were impacted by COVID-19 and the Company’s response to the pandemic. Selling and administrative expenses for three months ended March 31, 2020 included investment losses of $0.9 million recognized on assets associated with the Company’s Non-Qualified Deferred Compensation Plan, bad debt expense of $0.9 million on outstanding trade accounts receivable and severance expense of $0.4 million. These charges were partially offset by a reduction in expenses of $1.2 million resulting from forgoing the Company’s discretionary matching contribution under its defined contribution plan.

As a percentage of net sales, selling and administrative expenses for our Uniforms and Related Products segment was 30.3% for the three months ended March 31, 2020 and 31.0% for the three months ended March 31, 2019. The percentage decrease was primarily due to the increase in net sales explained above. 

As a percentage of net sales, selling and administrative expenses for our Remote Staffing Solutions segment was 36.9% for the three months ended March 31, 2020 and 36.3% for the three months ended March 31, 2019. As a percentage of net sales, selling and administrative expenses remained relatively flat.

As a percentage of net sales, selling and administrative expenses for our Promotional Products segment was 25.4% for the three months ended March 31, 2020 and 25.9% for the three months ended March 31, 2019. The percentage decrease was primarily related to the net sales increase explained above.

Interest Expense

Interest expense decreased to $1.1 million for the three months ended March 31, 2020 from $1.2 million for the three months ended March 31, 2019. This decrease was primarily due to a decrease in LIBOR rates, partially offset by a loss of $0.3 million recognized on our interest rate swap during the three months ended March 31, 2020.

Income Taxes

The effective income tax rate was 27.1% and 20.2% in the three months ended March 31, 2020 and 2019, respectively. The increase in the effective tax rate was primarily driven by rate increases of 3.7% for foreign taxes, 0.9% for state income taxes and 1.6% for non-deductible losses recognized on assets associated with the Company’s Non-Qualified Deferred Compensation Plan. The effective tax rate may vary from quarter to quarter due to unusual or infrequently occurring items, the resolution of income tax audits, changes in tax laws, the tax impact from employee share-based payments, taxes incurred in connection to the territorial style tax system, 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 strength of 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. Management currently believes that cash flows provided by operating activities and availability under the revolving credit facility will be sufficient to satisfy the Company’s anticipated working capital requirements for the next twelve months. The Company is proactively taking steps to increase available cash on hand by targeted reductions in discretionary cash outflows. The Company may also begin relying on the issuance of equity or debt securities. There can be no assurance that any such financings would be available to us on reasonable terms. Any future issuances of equity securities or debt securities with equity features 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
 
Cash and cash equivalents decreased by $3.2 million to $5.8 million as of March 31, 2020 from $9.0 million on December 31, 2019. Working capital decreased to $129.7 million at March 31, 2020 from $142.4 million at December 31, 2019. The decrease in working capital was primarily due to an increase in other current liabilities and decreases in trade accounts receivable and prepaid expenses and other current assets, partially offset by decreases in accounts payable and current portion of long-term debt. The increase in other current liabilities was driven by an increase of $15.8 million in contract liabilities primarily resulting from new customer contracts for the sourcing of personal protective equipment needed in response to COVID-19 within the Promotional Products and Uniform and Related Products segments. The decrease in trade accounts receivable was primarily driven by the timing of billings within the Promotional Products segment. The decrease in prepaid expenses and other current assets was primarily related to the timing of prepaid expenses. The decrease in accounts payable was primarily related to the timing of orders and payments to suppliers within the Uniform and Related Products and Promotional Products segments. The decrease in current portion of long-term debt was primarily due to the debt deferment agreements entered into in March 2020 that deferred contractual principal and interest payments on outstanding debt obligations due in the second quarter of 2020 until maturity.

Operating Activities. The increase in net cash provided by operating activities during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily attributable to the receipt of advance payments from new customer contracts for the sourcing of personal protective equipment needed in response to COVID-19 within the Promotional Products and Uniform and Related Products segments and the timing of advance payments made to vendors. Working capital cash changes during the three months ended March 31, 2020 included a decrease of $4.9 million in trade accounts receivable, an increase in accounts payable and other current liabilities of $4.7 million and a decrease in prepaid expenses and other current assets of $2.3 million. Working capital cash changes during the three months ended March 31, 2019 included a decrease of $2.2 million in prepaid expenses and other current assets.
 
Investing Activities. The increase in net cash used in investing activities during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was attributable to an increase in capital expenditures of $0.4 million. From a long-term perspective, the Company expects to continue its 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. In the near term, the Company expects to delay certain capital expenditures relating to non-essential projects until economic conditions begin to stabilize.
 
Financing Activities. The increase in net cash used in financing activities during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily attributable to an increase in net repayments of $17.9 million in debt. Excess cash generated from operating activities during the three months ended March 31, 2020 was used to repay outstanding borrowings under the revolving credit facility. 

Credit Facilities (See Note 3 to the Financial Statements)

As of March 31, 2020, the Company had approximately $101.6 million in outstanding borrowings under its amended and restated credit agreement (the “Credit Agreement”) with Truist Bank, consisting of $23.5 million outstanding under the revolving credit facility expiring in May 2023, $24.0 million outstanding under a term loan maturing in February 2024 (“2017 Term Loan”), and $54.2 million outstanding under a term loan maturing in January 2026 (“2018 Term Loan”). The revolving credit facility, 2017 Term Loan and 2018 Term Loan are collectively referred to as the “Credit Facilities”.

Obligations outstanding under the 2018 Term Loan have a variable interest rate of LIBOR plus a margin of between 0.85% and 1.65% (based on the Company’s funded debt to EBITDA ratio) (1.77% at March 31, 2020). Obligations outstanding under the revolving credit facility and the 2017 Term Loan generally have a variable interest rate of one-month LIBOR plus a margin of between 0.68% and 1.50% (based on the Company’s funded debt to EBITDA ratio) (1.60% at March 31, 2020). The available balance under the revolving credit facility is reduced by outstanding letters of credit. At March 31, 2020, the Company had undrawn capacity of $51.5 million under the revolving credit facility.
 

On March 30, 2020, the Company entered into debt deferment agreements with Truist Bank to: (i) defer contractual principal and interest payments due between April 1, 2020 and June 1, 2020 under the 2017 Term Loan and 2018 Term Loan until their respective maturity dates; and (ii) defer contractual interest payments due between April 1, 2020 and June 1, 2020 under the revolving credit facility until its maturity date. Contractual principal payments for the 2017 Term Loan are as follows: remainder of 2020 - $3.0 million; 2021 through 2023 - $6.0 million per year; and 2024 - $3.0 million. Contractual principal payments for the 2018 Term Loan are as follows: remainder of 2020 - $4.6 million; 2021 through 2025 - $9.3 million per year; and 2026 - $3.1 million. The term loans do not contain pre-payment penalties.

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, and sales of assets. The Credit Agreement also requires the Company to maintain a fixed charge coverage ratio (as defined in the Credit Agreement) of at least 1.25:1 and a funded debt to EBITDA ratio (as defined in the Credit Agreement) not to exceed 5.0:1. As of March 31, 2020, the Company was in compliance with these ratios. The Credit Facilities are secured by substantially all of the operating assets of the Company as collateral, 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.

Dividends and Share Repurchase Program
 
During each of the three months ended March 31, 2020 and 2019, the Company paid cash dividends of $1.5 million. 
 
On May 2, 2019, the Company’s Board of Directors approved a stock repurchase program of up to 750,000 shares of 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. Under this program the Company reacquired and retired 43,458 shares of its common stock during the three months ended March 31, 2020. At March 31, 2020, 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 the expected future cash needs.

Due to the anticipated continuing impact of the COVID-19 pandemic on the Company’s business, financial condition, results of operations and cash flows, the Company has elected to suspend its regular quarterly dividend until we have clearer visibility on improved macro conditions.

Shipments (Non-GAAP Financial Measure)

In this management’s discussion and analysis, we use a supplemental measure of our performance, which is derived from our financial information, but which is not presented in our financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). This non-GAAP financial measure is “shipments,” and represents a primary metric by which our management evaluates customer demand.

We define shipments as net sales excluding, if applicable, sales recorded with respect to contracts with customers in which there is an enforceable right to the payment for goods with no alternative use in advance of the transfer of these goods to our customers. As recognized in accordance with ASC 606, net sales generated from such contracts are recorded as of the time at which we receive the goods from our suppliers rather than at the time we transfer them to our customers. For customers to which we sell goods that have an alternative use, or customers with whom we do not have an enforceable right to payment with no alternative use, shipments and net sales are identical performance measures.

We believe that sales recorded under ASC 606 are affected by changes in the Company’s purchasing patterns that may not be directly aligned with customer demand. We believe that shipments, as a supplemental performance measure, tracks customer demand more closely.

Shipments is not a measure determined in accordance with GAAP, and should not be considered in isolation or as a substitute for sales determined in accordance with GAAP. Shipments is used as a measurement of customer demand and we believe it to be a helpful measure for those evaluating performance of a company operating in the uniform and related products business. However, there are limitations to the use of this non-GAAP financial measure. Our non-GAAP financial measure may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes.

The following tables reconcile net sales to shipments of our Uniform and Related Products segment (in thousands):

Off-Balance Sheet Arrangements

The Company does not engage in any off-balance sheet financing arrangements. In particular, the Company does not have any interest in variable interest entities, which include special purpose entities and structured finance entities.