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Superior Uniform Group Inc. (NASDAQ:SGC)

Q2 2014 Earnings Conference Call

July 23, 2014 2:00 PM ET

Executives

Hala Elsherbini – IR

Michael Benstock – CEO

Andrew Demott – CFO

Analysts

Michael Hughes – SGF Capital

Tom McGuire – Private Investor

Operator

Good afternoon, everyone, and welcome to the Superior Uniform Group’s Conference Call to discuss the company’s fiscal second quarter 2014 financial results. With us today are Michael Benstock, Chief Executive Officer of Superior Uniform Group and Andrew Demott, Chief Financial Officer.

After the speakers’ opening remarks, there will be a question-and-answer period and instructions to ask a question will be given at that time. This call is being recorded and your participation implies consent to the recording of this call. If you do not agree to these terms, please simply drop off the line.

I would now like to turn the conference call over to Hala Elsherbini, Senior Vice President of Halliburton Investor Relations who will read the Safe Harbor statement. Please go ahead.

Hala Elsherbini

Thank you, Jamie, and good afternoon, everyone. This conference call will contain forward-looking statements regarding Superior Uniform Group’s business opportunities and anticipated results of operations.

Please bear in mind that forward-looking information is subject to many risks and uncertainties and actual results may differ from what is projected. May it be risks and uncertainties are described in Superior Uniform Group’s annual report on Form 10-K for the year ended December 31, 2013. The company’s recent press release announced this morning and other filings with the SEC.

Forward-looking statements in this conference call are based on current expectations and beliefs and management does not undertake any duty to update any of the forward-looking statements made in this conference call or otherwise.

Please note that all growth comparisons management makes on today’s call will relate to the corresponding period of last year unless otherwise specified.

With that, I will now turn the call over to Michael.

Michael Benstock

Thank you, Hala, and good afternoon, everyone. Andy and I are very glad you could join us for Superior Uniform Group’s first earnings call in many years. This signals our renewed commitment to actively communicating with investors. You can expect to hear from us regularly going forward.

Here’s what to expect today. I would first like to provide highlights of our financial results for the second quarter that ended June 30th and then I will change my focus to offer some background on what distinguishes Superior and its two primary segments – uniforms and related products and Remote Staffing Solutions.

I’ll also provide some perspective on the industry growth drivers we see followed by the progress we have made on our growth strategies that diversify our business model, enhance our market share and expand into complementary product offerings while maintaining our superior standards of customer service.

Next, Andy will give you some context on the story behind our financial performance for the second quarter and in the first half. Finally, I’ll return with our general outlook on the second half, after which, we’ll be happy to answer your questions.

Let’s begin with the second quarter highlights. This has been a very busy and exciting quarter for the company. In fact, we delivered a record second quarter on our company’s nearly 95-year history. We carried forward momentum from our first quarter’s strong backlog and significantly increased the top line by 72.5% to $53.2 million from $30.9 million in the year ago quarter.

From a segment standpoint, our uniform business which is comprised of Fashion Seal Healthcare, HPI Direct and Superior ID executed on a large program rollout for an existing airline customer as well as a large promotional uniform order from an existing supermarket account.

This, coupled with stellar sales in most of our other uniform markets and specifically within HPI Direct which we acquired last July, led to an epic quarter. HPI designs, manufactures and distributes uniforms to major U.S. retailers, food service chains and transportation businesses. It’s important to note that we were able to nearly double HPI’s net sales during the last quarter. Excluding HPI, the uniforms segment grew organically by 14.3%.

Our remote staffing solution segment, The Office Gurus, is our call center and BPO business with offices in El Salvador, Belize and here at our Seminole, Florida headquarters. While still a small part of our overall sales, it continued its growth stream with net sales expanding more than 47% over last year’s second quarter.

For the total company, we maintained cost-efficiencies which contributed to the increases in our consolidated bottom line at a dramatic rate. Net earnings rose nearly 172% and earnings per diluted share grew by almost 148% despite more than a 10% increase in shares outstanding. Andy will provide additional details on the numbers and other key performance measures in a few minutes.

Now let me shift my focus to give you a frame of reference on our competitive advantages, market trends and our long-term growth strategies. As you may know, uniforms and related products generate about 95% of our sales with our newer venture, Remote Staffing Solutions, contributing the rest.

I believe there are five key factors that make Superior unique. First, we have the broadest uniform product lines in the industry. It’s more extensions than most of the larger players serving the market in addition to all of the many smaller national and regional businesses.

Second, we reach more markets than any single competitor of any size. We can cost-effectively cover almost any vertical market from healthcare to food service to transportation to private security and many more chain store businesses.

Third, as you know, we are financially strong. As Andy will explain, we have a solid balance sheet and access to a capital that we need or that we may need. This allows us to move aggressively to expand our business as opportunities arise, continue to reduce our debt and reward shareholders with a regular dividend. It also gives us a competitive advantage when competing against smaller businesses, many of whom are unable to handle the magnitude of needed investments to develop large new programs.

Fourth, Superior has an excellent garment sourcing network in about 10 countries. That means we buy products at very competitive prices. And we also maintain our innovative in-house design capabilities that not even large competitors can match.

And finally, The Office Gurus provides the back office support for our core uniforms sales group in addition to the outside customers that it serves. Our multi-lingual telemarketing and call center team provide an array of administrative functions from product support, order entry, collections, telemarketing, as well as award-winning customer care support to an increasing number of outside customers.

When it comes to our industry, we are starting to see two long-awaited positive drivers. Our performance drives when the economy is doing well. This produces low unemployment and higher turnover rates as people who work in hospitals, private security and chain businesses that we serve leave one job for the next. We are starting to see a gradual increase in turnover rates reflecting more confidence in the job market which should translate into continued improvement in our overall performance as well. In addition, we’re seeing more optimism in our customer base with many customers opening new stores, rebranding and expanding their businesses.

The second trend relates to healthcare. Some of the uncertainty surrounding the Affordable Care Act is now gone. Millions of people are eligible for healthcare who weren’t before, which should increase demand for and employment in the healthcare industry.

We also are seeing consolidation in the healthcare market both on the laundry side and on the direct healthcare side of our business with customers acquiring their smaller competitors in order to remain viable. Fashion Seal Healthcare works with some of the most prestigious healthcare integrated delivery networks in the country. We anticipate further expanding our reach into integrated delivery network systems as well as into new healthcare niches such as long-term care and home health.

Overall, our results were a direct result of the progress we made on our long-term growth strategies and our improved market position. We are expanding our penetration of the healthcare market by creating new regional distribution relationships with some of the biggest integrated healthcare network companies. And we are also expanding sales to our laundry customers. We’re also reaching long-term care and home healthcare companies as well as private medical colleges.

We’re working very hard at elevating our Fashion Seal Healthcare brand through various awareness programs, branding, cataloging and targeted marketing programs. This has been in process over the last three years. And we have progressed nicely in establishing Fashion Seal’s own brand and identity.

In addition, we strengthened our direct sales effort, and as a result, we won contracts with two of the largest healthcare providers in the country. This gives us much broader access to hospital platforms around the nation which should provide a healthy long-term contribution to our performance.

We also continue to seek opportunistic acquisitions that present high growth potential, either open new markets or enhance existing ones. Our acquisition of HPI a year ago is a prime example of our ability to execute accretive acquisitions that provide a significant incremental contribution to our top and bottom lines. We constantly review uniform businesses that would be a good fit from both a product and cultural standpoint. We are seeing a robust pipeline and we are well positioned with solid financial footing to act when the right opportunities arise.

Our diversification into Remote Staffing Solutions has served us well. While our operations remain lean, we’re expanding them in certain areas to handle growth. We are seeing continued strong demand for The Office Guru services offering them and us as we are securing new customer engagements. In fact, we are expanding capacity at our main center in San Salvador to seek nearly 600 additional employees. Our centers in Florida and Belize continue to expand as well.

Finally, our promotional products business is a seamless extension of our branding activities with our customers. Combining forces with HPI, we believe we have the scalability to be a sizable promotional product supplier through acquisitions and organic growth. It makes sense from a purchasing perspective because often the same person who purchases uniforms – the marketing, our human resources director is responsible for buying these products as well.

I’ll now turn the call over to Andy for the financial review. After Andy concludes, I’d like to provide some closing remarks and then we’ll move to Q&A. Andy?

Andrew Demott

Thank you, Michael, and good afternoon everyone. I’m also very pleased with the outstanding financial results for the second quarter. Since our press release is available on our website and our 10-Q was filed this morning, I’m going to add color around some of the key factors in the quarter.

Let’s start with the income statement. The 72.5% increase in net sales for the latest three months to $53.2 million from $30.9 million a year ago came largely from our acquisition of HPI. Excluding HPI, sales still grew but 15.6%.

Taking a closer look at HPI, net sales expanded by 94% over last year’s second quarter, primarily due to shipments of significant new programs including a transportation customer which accounted for approximately $5 million of our increase in net sales.

Sales of the uniforms and related products business without HPI rose 14.3% as a result of our successful market penetration and increased market share and as well as the large promotional uniform program for a large supermarket customer. The Remote Staffing Solutions business experienced a 47.2% improvement in net sales over the last year as it continued to sign new contracts.

Cost of goods sold increased by 73.9% to $34.2 million as a result of higher company-wide sales. Gross margins declined slightly to 35.7% for the latest quarter versus 36.2% a year ago.

Selling and administrative expenses rose at a much lower rate than sales and increased 43.1% from a year ago to $13 million. As a percent of sales, SG&A dropped to 24.5% compared with 29.5% in the 2013 quarter. The takeaway here is that we have done a good job of integrating the HPI position, leveraging our fixed cost and benefiting from economies of scale.

Interest expense increased to $113,000. This resulted from two actions – first, funding the HPI acquisition at the beginning of the third quarter of 2013; and second, increased use of our use [ph] of our revolving credit facilities primarily to fund the buildup of inventory for the two large program rollouts in the second quarter. While we expect interest expense will be lower in the third quarter related to our revolving credit facilities as we pay down our debt, we will see an offsetting increase in interest expense related to approximately $14.2 million of the acquisition term loan.

The interest rate swap agreement that we entered into last July following the acquisition went into effect on July 1st of this year. As a result, the interest rate on that portion of the term loan will increase from the floating rate of 1.2% as of June 30th to 2.5%, 3% through the loan’s maturity on July 1, 2018.

Income from operations climbed to 183.7% to $5.9 million. That led to a higher operating margin at 11.2% compared with 6.7% for last year’s second quarter. Our effective tax rate rose to 33.4% from 30.5%. Our earnings in El Salvador and Belize are considered to be permanently reinvested there and as such, no U.S. tax provision is provided for their earnings. Additionally, we pay minimal income taxes in El Salvador and Belize. As a result of the significant increase in our domestic income in the current period, our foreign income is now a much smaller percentage of the overall income.

All of these factors related to each operating division created a 171.7% increase in net income for the quarter to $3.9 million. On a diluted per share basis, we posted a 147.8% increase in earnings to $0.57. This included a 10.6% increase in shares outstanding primarily reflecting $200,000 additional restricted shares related to the HPI acquisition as well as the impact of increased option exercises over the last year. In addition, we continued our pattern of issuing a quarterly dividend of $0.135 per share.

Let’s move to a quick review of first half 2014 highlights. Net sales grew 52.4% to $94.3 million. Once again, the biggest difference came from the HPI acquisition. Compared with the first six months of 2013, our revenues from our uniforms and related products segment increased 52.6% and Remote Staffing Solutions expanded 47.7%.

Our gross margin was 35.1% versus 36.4% for last year’s first half. This change reflect a competitive price from the market which was slightly offset by lower overhead as a percentage of sales because of our higher volume of sales.

Operating income more than doubled to $7.7 million. For the latest six months, this represented 8.2% of sales compared with 6.2% a year ago. Net income for the first half was $5.1 million, a 92% improvement from a year ago. And diluted earnings per share rose 74% to $0.75.

Now for the balance sheet highlight, our cash and equivalents remained strong in $5 million. Accounts receivable expanded to $31.2 million growing 37.4% in tandem with the higher sales. This also was true for inventories which rose 15.7% to $57.3 million so far this year.

Long-term debt increased to $34.8 million to fund the increase working capital associated with the large programs I discussed earlier. And shareholders equity expanded 7.1% to $77.1 million. Our development pipelines remain strong in both of our business units and as Michael mentioned we’re also evaluating acquisition candidates.

As you can see, our financial strength and access to capital give us the flexibility to take advantage of these opportunities. Now I’ll turn the call back to Michael to share his perspective on the balance of this year and provide his closing remarks. Michael?

Michael Benstock

Thanks, Andy. We’re pleased with our second quarter results, which by most measures, was out best performing quarter in our history. This is a truly transformational year for our company. Over the past few years, we have jettisoned less than profitable businesses focused on two growing businesses that offered good margins and are growing both organically and through acquisitions.

I believe the company has never been in better financial shape and we have the right team in place to continue to execute on our growth strategies. While we do not provide guidance, I’m happy to provide a current outlook.

There are few things we’re watching. The uniform business saw some pricing pressure in the first half, so this may continue. The midterm elections could distract some purchasing decisions. The current volatility in the Middle East does not directly affect us. However, it can have an impact on the economy and some of our customers. We also are monitoring the pressures globally to raise minimum wages.

Historically, we have done a good job of managing market risks. These have ranged from the cotton crisis to earthquakes to the recession. We’re able to do this by controlling cost, maintaining operating efficiencies through automated distribution systems, redundant manufacturing and innovative sourcing strategies as well as always maintaining a flat organizational structure.

More importantly, we have the best team that could possibly be put together to execute on our strategies. They truly rock. As you may imagine several factors came together and well aligned in order for us to deliver a stellar second quarter results in this magnitude.

Much of this has to do with the first anniversary of the HPI acquisition. While the level of second quarter earnings is not to be expected each quarter, our overall backlog in the uniforms and related product segment remain strong. And overall we do anticipate healthy increases in the top and bottom line for the second half.

I know this is a lot of information. By now I’m sure you have some questions. Andy and I will be happy to answer them. I would like to now open it up for Q&A. Operator?

Question-and-Answer Session

Operator

And ladies and gentlemen, at this time we will open the floor for questions. (Operator instructions) We will pause momentarily to assemble the roster. (Operator instructions)

And we do have a question from Mike Hughes from SGF Capital. Please go ahead with your question.

Michael Hughes – SGF Capital

Yes, a couple of questions for you. Just first on the new airline customer, nice order, nice win on the HPI side. Just the nature of your business, when would they be back in the market for more product? How does that work overtime?

Michael Benstock

So in fact there are a lot of ways with this, Michael. And thanks for the question. There are a lot of ways the rollouts are done. But typically we would roll out a program like this and almost immediately we would begin servicing the employees of that account with their individual needs.

So there are really – there’s a huge rollout on the frontend but then there’s continued business opportunities every single day. So it winds down a little bit but it doesn’t wind down completely.

Michael Hughes – SGF Capital

Okay. And then just the special promotion you ran in the second quarter. I think you said for a supermarket customer, it’s $2.5 million. What’s the background on that deal? Was it just a competitive deal and you needed to run the promo to retain the business?

Michael Benstock

No. Let me clarify that. We have a promotional products business. We have products that we sell that – they’re also known as ad specialty items. And they may be T-shirts or caps or mugs and cups and key chains.

And so the promotional products that we sold in existing supermarket account, a promotion that they were having, we supplied all the materials for that promotion.

Michael Hughes – SGF Capital

Okay. I appreciate the clarification. And then just the operating cash flow, you highlighted in your prepared comments inventory and AR, eating up some cash flow on the first half. Do you think that the back half that completely reverses itself and you could actually generate positive operating cash flow for the full year?

Andrew Demott

I definitely expect that we will turn the trend around in the second half. We’ve already seen that through the month of July with some significant collections. So this is associated with those two programs that we discussed.

And that we’re in the position to say where we’re going to be for the full year.

Michael Hughes – SGF Capital

Right. And then the SG&A at the $13 million a quarter run rate, is that a good number to use for the third and fourth quarter this year?

Michael Benstock

It really moves with the sales. It doesn’t increase at the same rate. That sales go up and we typically look at it as the percentage of sales. There’s a fair portion of that SG&A that will remain consistent. But then there’s a variable portion associated with it as well.

Michael Hughes – SGF Capital

Okay.

Michael Benstock

If you look back in our history, you’ll see the trends on where increases and decreases in our revenues, how they move with the sales.

Michael Hughes – SGF Capital

Okay. And then I think there’s a stock comp for the quarter was a 128,000, it was 827 in the first quarter. What accounts for the differences? I would think the stock prices higher, it might be higher but it won’t just – that looked like in the back half?

Andrew Demott

Yes. Let me explain the way our stock compensation program runs in a normal year and which is pretty well every year. In February of this year, the compensation committee issues are large grants to our management team, both our section 16 officers as well as the rest of the officers and directors of the company.

Mid-year in the second quarter is a grant that is none to our outside directors, our executive board of directors. And then in the third quarter in July or August of each year there’s a ranking file stock ups in grant. So those will happen in each of the three years.

There is a significant increase in the cost of our option this year with the combination of two factors. The higher share price, when you’re using the Black-Scholes model that kicks in as well as the fact that our volatility of the stock has increased over the last several years which has led to higher expense as well.

Michael Hughes – SGF Capital

All right, okay.

Andrew Demott

And the number of options that we’ve been giving have been relatively consistent.

Michael Hughes – SGF Capital

Okay. Then one last question for you on remote staffing. I think it was in the Q or the K [ph] that you plan on expanding that and your referenced 600 seats plan there. It’s going to be $7 million. Is that the CapEx number and over what timeframe will they’d be completed?

Michael Benstock

Well, I hope to soon be closing on some land in the very near future. And we expect within 12 months after that that we’ll have spent that $7 million and we’ll have a – we’ll be operating at that facility.

Michael Hughes – SGF Capital

Okay. And are there operating startup cost when you bring that many seats online that would weigh on margins in just in short term?

Michael Benstock

It’s not our intention to bring all those seats online immediately. It’s our intention to, at our current rate of growth, to grow into that over a period of a few years.

Michael Hughes – SGF Capital

Okay, thank you very much.

Michael Benstock

Thank you.

Andrew Demott

Thank you.

Operator

(Operator instructions) Our next question comes from Tom McGuire who is a private investor. Please go ahead with your question.

Tom McGuire – Private Investor

Okay, thank you for taking my question, and a really good quarter. I have a quick follow up question to the gentlemen’s first question. And it is, how unusual is it for HPI or you guys to get an order of the magnitude of $5 million or even $2.5 million from a customer. Is that kind of like one off business or can that happen regularly, it’s just hard to time when they come?

Michael Benstock

I wish they happened every month, but it’s not a one off. I mean, in our history almost every year, I could speak to large rollouts that we’ve had, it’s just never quite call comes together at the same time as this did.

Last year, we had a large rollout of an auto parts chain and that was significant. We seemed to be able to replace sometimes these bigger ones with smaller incremental business with multiple customers that you don’t see the swings as much as you saw on this one. But we’re pretty confident that we’re positioned now with HPI as our partner to be able to go after more business like this and be able to service it well because truly, they took on a large piece of business, maybe the largest piece of business they’d ever taken on. I’m not certain of that. But they handled this. But certainly, the most complex piece of business they’ve ever taken on and they handled it very, very well. So we’re very confident that we’re open to many more opportunities like this in the future.

Tom McGuire – Private Investor

Okay, thank you very much and good job.

Michael Benstock

Thank you.

Operator

And everyone at this time, I’m showing no additional questions. I’d like to turn the conference call back over to Michael Benstock for any closing remarks.

Michael Benstock

Thank you, Jamie. I’d like to leave you all with three final thoughts. For the last few years, Superior has focused on transforming itself into a growth company. We did this by getting out of unprofitable businesses, controlling our inventories, cutting cost, hiring the right team and reinvesting in the business even in the face of the recession to improve our competitive position.

This means our business model has low overhead and a lot of upside potential in our operating margins as we add new customers. We reached diverse markets and can grow organically and through acquisitions. Because we are low debt levels, we can leverage for the right growth opportunities. Andy and I thank you for taking the time to be with us today.

As I mentioned at the top of this call, our management team is committed to keeping you informed about the company. We look forward to providing our third quarter update in October.

In the meantime, we hope you have an enjoyable summer.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending today’s presentation. You may now disconnect your telephone lines.

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