Superior Group of Companies, Inc.: Form 10-Q for the period ended Jun 30, 2023

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

Cautionary Note Regarding Forward Looking Statements

Certain matters discussed in this Form 10-Q are “forward-looking statements” intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified by use of the words “may,” “will,” “should,” “could,” “expect,” "anticipate,” “estimate,” “believe,” “intend,” “project,” “potential,” or “plan” or the negative of these words or other variations on these words or comparable terminology. Forward-looking statements in this Quarterly Report on Form 10-Q may include, without limitation: (1) projections of revenue, income, and other items relating to our financial position and results of operations, including short term and long term plans for cash, (2) statements of our plans, objectives, strategies, goals and intentions, (3) statements regarding the capabilities, capacities, market position and expected development of our business operations, (4) statements of expected industry and general economic trends and (5) the projected impact of the COVID-19 pandemic on our, our customers’, and our suppliers’ businesses.

Such forward-looking statements are subject to certain risks and uncertainties that may materially adversely affect the anticipated results. Such risks and uncertainties include, but are not limited to, the following: the impact of competition; uncertainties related to supply disruptions, inflationary environment (including with respect to the cost of finished goods and raw materials and shipping costs), employment levels (including labor shortages) and general economic and political conditions in the areas of the world in which the Company operates or from which it sources its supplies or the areas of the United States of America (“U.S.” or “United States”) in which the Company’s customers are located; changes in the healthcare, retail, hotel, food service, transportation and other industries where uniforms and service apparel are worn; our ability to identify suitable acquisition targets, discover liabilities associated with such businesses during the diligence process, successfully integrate any acquired businesses, or successfully manage our expanding operations; the price and availability of cotton and other manufacturing materials; attracting and retaining senior management and key personnel; the effect of the Company’s material weakness in internal control over financial reporting; the Company’s ability to successfully remediate its material weakness in internal control over financial reporting and to maintain effective internal control over financial reporting; lingering effects of the COVID-19 pandemic, including existing and possible future variants, on the United States and global markets, our business, operations, customers, suppliers and employees, including the length and scope of restrictions imposed by various governments and organizations and the continuing success of efforts to deliver effective vaccines and boosters, among other factors; and other factors described in the Company’s filings with the Securities and Exchange Commission, including those described in the “Risk Factors” section herein and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements made herein and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Form 10-Q and we disclaim any obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances, except as may be required by law.

Recent Acquisitions

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

Business Outlook

Superior Group of Companies, Inc. (together with its subsidiaries, the “Company,” “Superior,” “we,” “our,” or “us”) is comprised of three reportable business segments: (1) Branded Products, (2) Healthcare Apparel and (3) Contact Centers.

Branded Products

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

Healthcare Apparel

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

Contact Centers

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

Global Economic and Political Conditions

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

Prolonged or recurring disruptions or instability in the United States and global economies, and how the world reacts to those disruptions or instability, could have long-term impacts on our business. These business impacts could negatively affect us in a number of ways, including, but not limited to, reduced demand for our core products and services, reductions to our revenue and profitability, costs associated with complying with new or amended laws and regulations affecting our business, declines in our stock price, reduced availability and less favorable terms of future borrowings, valuation of our pension obligations, reduced credit-worthiness of our customers, and potential impairment of the carrying value of indefinite-lived intangible assets. Some of these impacts, such as reduced demand in our Branded Products segment related to reduced advertising spending by our customers, and reduced demand in our Healthcare Apparel segment resulting from a continuation of challenging market conditions with saturated inventory levels post-COVID-19 pandemic, have already materialized, and are described in “Operations” below.

Summary of Results

Net Income (Loss)

The Company generated net income of $1.2 million during the three months ended June 30, 2023 and net loss of $26.7 million during the three months ended June 30, 2022. The increase in net income during the three months ended June 30, 2023 compared to the three months ended June 30, 2022 was primarily due to goodwill and indefinite-lived intangible assets impairment charges totaling $30.0 million during the three months ended June 30, 2022 and a decrease in inventory write-downs of $4.4 million, partially offset by an increase in interest expense, an increase in income tax expense and an increase in Contact Centers selling and administrative expenses. The Company generated net income of $2.1 million during the six months ended June 30, 2023 and net loss of $21.4 million during the six months ended June 30, 2022. The increase in net income during the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was primarily due to goodwill and indefinite-lived intangible assets impairment charges totaling $30.0 million during the six months ended June 30, 2022 and a decrease in inventory write-downs of $4.7 million, partially offset by an increase in interest expense, an increase in Contact Centers selling and administrative expenses and a decrease in Branded Products net sales.

Adjusted EBITDA

Adjusted EBITDA (a non-GAAP financial measure) was $7.4 million and $4.8 million during the three months ended June 30, 2023 and 2022, respectively. Adjusted EBITDA during the three months ended June 30, 2023 compared to the three months ended June 30, 2022 increased primarily due to a decrease in inventory write-downs, partially offset by an increase in Contact Centers selling and administrative expenses. Adjusted EBITDA was $14.3 million and $14.8 million during the six months ended June 30, 2023 and 2022, respectively. Adjusted EBITDA during the six months ended June 30, 2023 compared to the six months ended June 30, 2022 decreased primarily due to an increase in Contact Centers selling and administrative expenses and a decrease in Branded Products net sales, partially offset by a decrease in inventory write-downs. For a reconciliation of Adjusted EBITDA to net income, its most directly comparable financial measure calculated and presented in accordance with GAAP, please read “Non-GAAP Financial Measure” below.

Operations

Three Months Ended June 30, 2023 Compared to Three Months Ended June 30, 2022

Net Sales (in thousands):

Net sales for the Company decreased 12.7%, or $18.8 million, for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. The decrease was driven by a decline in Branded Products net sales, partially offset by net sales increases in Healthcare Apparel and Contact Centers.

Branded Products net sales decreased 22.0%, or $22.4 million, for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. The decrease was primarily due to decreased demand as a result of current market conditions that have tightened our customers’ advertising spending, the timing of new branded uniform rollout programs for certain customers and a decrease of $0.9 million in net sales of personal protective equipment driven by the easing of the COVID-19 pandemic. These decreases were partially offset by net sales of $3.0 million attributable to the acquisition of Guardian in May 2022.

Healthcare Apparel net sales increased 6.8%, or $1.8 million, for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. The increase was primarily due to an increase in digital sales, including the launch of a direct-to-consumer website in the current year period.

Contact Centers net sales increased 6.0% before intersegment eliminations and 9.7% after intersegment eliminations for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. These increases were primarily attributed to the onboarding of new customers during the last twelve months.

Gross Margin

Gross margin rate for the Company was 36.8% for the three months ended June 30, 2023 and 32.5% for the three months ended June 30, 2022. The rate increase was primarily due to $4.5 million in inventory write-downs of excess inventory related to personal protective equipment and discontinued styles during the three months ended June 30, 2022 and an improvement in gross margin rate for our Branded Products segment, the Company's largest segment.

Gross margin rate for our Branded Products segment was 32.2% for the three months ended June 30, 2023 and 28.5% for the three months ended June 30, 2022. The rate increase was primarily driven by a favorable shift in the mix of pricing and customers and $1.3 million in inventory write-downs of personal protective equipment during the three months ended June 30, 2022.

Gross margin rate for our Healthcare Apparel segment was 37.1% for the three months ended June 30, 2023 and 28.1% for the three months ended June 30, 2022. The rate increase was primarily driven by $3.2 million in inventory write-downs of excess inventory related to personal protective equipment and discontinued styles during the three months ended June 30, 2022, partially offset by the impact of challenging market conditions and strategic efforts to right size inventory levels resulting in lower selling prices.

Gross margin rate for our Contact Centers segment was 53.6% for the three months ended June 30, 2023 and 59.5% for the three months ended June 30, 2022. The rate decrease was primarily due to increased employee related costs of our agents, partially offset by price increases.

Selling and Administrative Expenses

As a percentage of net sales, total selling and administrative expenses was 33.6% for the three months ended June 30, 2023 and 31.1% for the three months ended June 30, 2022. The rate increase was primarily attributed to expense deleverage resulting from the 22.0% decrease in Branded Products net sales and an increase in headcount to support growth in our Contact Centers segment, partially offset by lower selling and administrative expenses resulting from a decrease in bad debt expense of $1.2 million and a decrease in sales commission expense.

As a percentage of net sales, selling and administrative expenses for our Branded Products segment was 25.6% for the three months ended June 30, 2023 and 23.5% for the three months ended June 30, 2022. The rate increase was primarily due to expense deleverage on the 22.0% decrease in net sales, partially offset by lower selling and administrative expenses resulting from a decrease in bad debt expense of $1.2 million and a decrease in sales commission expense.

As a percentage of net sales, selling and administrative expenses for our Healthcare Apparel segment was 33.7% for the three months ended June 30, 2023 and 37.3% for the three months ended June 30, 2022. The rate decrease was primarily driven by a slight decrease in expenses on higher net sales explained above.

As a percentage of net sales, selling and administrative expenses for our Contact Centers segment was 42.2% for the three months ended June 30, 2023 and 39.1% for the three months ended June 30, 2022. The rate increase was primarily attributed to increased investment in organizational infrastructure, including personnel, to support future growth of this segment.

Goodwill Impairment Charge

In conjunction with the re-segmentation during the second quarter of 2022, the Company performed a goodwill impairment analysis and determined that the estimated fair value of the previous Uniforms and Related Products segment was lower than its carrying value primarily as the result of then-current market conditions, decline in expected cash flows and decrease in the Company’s stock price. Consequently, the Company recorded a non-cash goodwill impairment charge of $24.5 million during the three months ended June 30, 2022.

Intangible Assets Impairment Charge

In conjunction with the Company’s realignment of its reportable segments, the Company began an effort to centralize certain branding and go-to-market strategies under the BAMKO brand and determined that it would no longer use certain trade names associated with branded products. The Company’s rebranding efforts resulted in a $5.6 million impairment of indefinite-lived trade names related to its Branded Products segment during the three months ended June 30, 2022.

Interest Expense

Interest expense increased to $2.6 million for the three months ended June 30, 2023 from $0.6 million for three months ended June 30, 2022. This increase was primarily due to an increase in interest rates on our outstanding borrowings. The weighted average interest rate on our outstanding borrowings for the three months ended June 30, 2023 was 7.2% compared to 1.6% for the three months ended June 30, 2022.

Income Taxes

Income tax expense for the three months ended June 30, 2023 compared to the three months ended June 30, 2022 increased by $2.5 million. The effective income tax rate was 11.8% and 8.0% for the three months ended June 30, 2023 and 2022, respectively. Income tax expense for the three months ended June 30, 2022 was impacted by a federal tax benefit of $2.0 million relating to the impairment of intangible assets and a portion of the goodwill impairment. The effective tax rate for the three months ended June 30, 2022 was impacted by the nondeductible portion of the goodwill impairment charge totaling $20.3 million. The effective tax rate may vary from quarter to quarter due to discrete, unusual or non-recurring items, the resolution of income tax audits, changes in tax laws, the tax impact from employee share-based payments, or other items.

Six Months Ended June 30, 2023 Compared to Six Months Ended June 30, 2022

Net Sales (in thousands):

Net sales for the Company decreased 10.8%, or $31.6 million, for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The decrease was primarily driven by a decline in Branded Products net sales, partially offset by an increase in Contact Centers net sales.

Branded Products net sales decreased 18.9%, or $37.7 million, for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The decrease was primarily due to decreased demand as a result of current market conditions that have tightened our customers’ advertising spending, the timing of new branded uniform rollout programs for certain customers and a decrease of $4.7 million in net sales of personal protective equipment driven by the easing of the COVID-19 pandemic. These decreases were partially offset by net sales of $9.5 million attributable to the acquisition of Guardian in May 2022.

Healthcare Apparel net sales decreased 1.1%, or $0.6 million, for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The decrease was primarily due to a decrease in demand for healthcare apparel resulting from a continuation of challenging market conditions with saturated inventory levels post-COVID-19 pandemic, partially offset by an increase in digital sales, including the launch of a direct-to-consumer website in the current year period.

Contact Centers net sales increased 13.6% before intersegment eliminations and 18.9% after intersegment eliminations for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. These increases were primarily attributed to onboarding of new customers during the last twelve months and providing expanded services to our existing customers.

Gross Margin

Gross margin rate for the Company was 36.4% for the six months ended June 30, 2023 and 33.6% for the six months ended June 30, 2022. The rate increase was primarily due to $4.5 million in inventory write-downs of excess inventory related to personal protective equipment and discontinued styles during the six months ended June 30, 2022 and an improvement in gross margin rate for our Branded Products segment, the Company's largest segment.

Gross margin rate for our Branded Products segment was 31.9% for the six months ended June 30, 2023 and 28.8% for the six months ended June 30, 2022. The rate increase was primarily driven by a favorable shift in the mix of pricing and customers and $1.3 million in inventory write-downs of personal protective equipment during the six months ended June 30, 2022.

Gross margin rate for our Healthcare Apparel segment was 36.5% for the six months ended June 30, 2023 and 34.1% for the six months ended June 30, 2022. The rate increase was primarily driven by $3.2 million in inventory write-downs of excess inventory related to personal protective equipment and discontinued styles during the six months ended June 30, 2022, partially offset by the impact of challenging market conditions and strategic efforts to right size inventory levels resulting in lower selling prices.

Gross margin rate for our Contact Centers segment was 53.5% for the six months ended June 30, 2023 and 59.5% for the six months ended June 30, 2022. The rate decrease was primarily due to increased employee related costs of our agents, partially offset by price increases.

Selling and Administrative Expenses

As a percentage of net sales, total selling and administrative expenses was 33.4% for the six months ended June 30, 2023 and 30.2% for the six months ended June 30, 2022. The rate increase was primarily attributed to expense deleverage resulting from the 18.9% decrease in Branded Products net sales and an increase in headcount to support growth in our Contact Centers segment, partially offset by lower selling and administrative expenses resulting from a decrease in bad debt expense of $1.9 million, a decrease in acquisition contingent liabilities, a decrease in sales commission expense and investment losses in the prior year period related to Company’s supplemental executive retirement plan.

As a percentage of net sales, selling and administrative expenses for our Branded Products segment was 25.0% for the six months ended June 30, 2023 and 22.9% for the six months ended June 30, 2022. The rate increase was primarily due to expense deleverage on the 18.9% decrease in net sales, partially offset by lower selling and administrative expenses resulting from a decrease in bad debt expense of $1.6 million, a decrease of $1.0 million in acquisition contingent liabilities and a decrease in sales commission expense.

As a percentage of net sales, selling and administrative expenses for our Healthcare Apparel segment was 33.7% for the six months ended June 30, 2023 and 35.0% for the six months ended June 30, 2022. The rate decrease was primarily due to by lower selling and administrative expenses resulting from a decrease in employee related expenses, including sales commissions.

As a percentage of net sales, selling and administrative expenses for our Contact Centers segment was 43.0% for the six months ended June 30, 2023 and 37.5% for the six months ended June 30, 2022. The rate increase was primarily attributed to increased investment in organizational infrastructure, including personnel, to support future growth of this segment.

Goodwill Impairment Charge

In conjunction with the re-segmentation during the second quarter of 2022, the Company performed a goodwill impairment analysis and determined that the estimated fair value of the previous Uniforms and Related Products segment was lower than its carrying value primarily as the result of then-current market conditions, decline in expected cash flows and decrease in the Company’s stock price. Consequently, the Company recorded a non-cash goodwill impairment charge of $24.5 million during the six months ended June 30, 2022.

Intangible Assets Impairment Charge

In conjunction with the Company’s realignment of its reportable segments, the Company began an effort to centralize certain branding and go-to-market strategies under the BAMKO brand and determined that it would no longer use certain trade names associated with branded products. The Company’s rebranding efforts resulted in a $5.6 million impairment of indefinite-lived trade names related to its Branded Products segment during the six months ended June 30, 2022.

Interest Expense

Interest expense increased to $5.2 million for the six months ended June 30, 2023 from $0.9 million for six months ended June 30, 2022. This increase was primarily due to an increase in interest rates on our outstanding borrowings. The weighted average interest rate on our outstanding borrowings for the six months ended June 30, 2023 was 6.9% compared to 1.3% for the six months ended June 30, 2022.

Income Taxes

Income tax expense for the six months ended June 30, 2023 compared to the six months ended June 30, 2022 increased by $0.8 million. The effective income tax rate was 9.5% and 3.6% for the six months ended June 30, 2023 and 2022, respectively. Income tax expense for the six months ended June 30, 2022 was impacted by a federal tax benefit of $2.0 million relating to the impairment of intangible assets and a portion of the goodwill impairment. The effective tax rate for the six months ended June 30, 2022 was impacted by the nondeductible portion of the goodwill impairment charge totaling $20.3 million. The effective tax rate may vary from quarter to quarter due to discrete, unusual or non-recurring items, the resolution of income tax audits, changes in tax laws, the tax impact from employee share-based payments, or other items.

Liquidity and Capital Resources

Overview

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

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

Working Capital

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

Cash and cash equivalents increased by $1.0 million to $18.7 million as of June 30, 2023 from $17.7 million on December 31, 2022. Working capital decreased to $205.3 million at June 30, 2023 from $232.8 million at December 31, 2022. The decrease in working capital was primarily due to a decrease in inventory, a decrease in accounts receivable, an increase in accounts payable, a decrease in contract assets and a decrease in other accounts receivable, partially offset by a decrease in other current liabilities. The decrease in inventory and increase in accounts payable were primarily driven by the timing of payments to vendors and a decrease in purchasing activities during the period. The decreases in accounts receivable and other accounts receivables were primarily related to decreased sales for our Branded Products segment and the collection of customer payments, including credit card payments. The decrease in contract assets was primarily driven by the timing of shipments to customers and receipts from suppliers for finished goods with no alternative use within our Branded Products segment. The decrease in other current liabilities was primarily related to the timing of payments associated with costs incurred in 2022 that were paid in 2023, including accrued commissions and other compensation.

Material Short-Term Plans for Cash

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

Material Long-Term Plans for Cash

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

Cash Flows

Our cash flows from operating, investing and financing activities, as reflected in the statements of cash flows, are summarized in the following table (in thousands):

Operating Activities. The increase in net cash provided by operating activities during the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was primarily attributable to decreases in cash outflows for inventory and accounts payable and an increase in cash inflows from accounts receivable and contract assets, partially offset by a decrease in net sales and an increase in interest paid. Working capital cash changes during the six months ended June 30, 2023 included a decrease of $10.6 million in inventory, a decrease of $8.9 million in accounts receivable and a decrease of $5.4 million in contract assets. Working capital cash changes during the six months ended June 30, 2022 included an increase of $9.4 million in inventory, an increase of $8.2 million in contract assets and a decrease of $7.3 million in accounts payable and other current liabilities.

Investing Activities. The decrease in net cash used in investing activities during the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was attributable to $11.1 million of cash paid for the acquisition of Guardian in 2022 and a decrease of $3.4 million in capital expenditures.

Financing Activities. The increase in net cash used by financing activities during the six months ended June 30, 2023 compared to the six months ended June 30, 2022 was primarily attributable to $28.9 million in net repayments of debt in the current period compared to $32.5 million of net borrowings of debt in the prior year period. Excess cash generated from operating activities during the six months ended June 30, 2023 was used to repay outstanding borrowings under the revolving credit facility.

Credit Facilities (See Note 3 to the Financial Statements)

As of June 30, 2023, the Company had $127.3 million in outstanding borrowings under its Credit Facilities (as defined below), consisting of $56.0 million outstanding under the revolving credit facility and $71.3 million outstanding under a term loan. As of June 30, 2023, the Company had undrawn capacity of $69.0 million under the revolving credit facility.

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

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

Obligations outstanding under the Credit Facilities accrue interest at a variable rate equal to the secured overnight financing rate (“SOFR”) plus an adjustment of between 0.10% and 0.25% (depending on the applicable interest period) plus a margin of between 1.0% and 2.0% (depending on the Company’s net leverage ratio). During the covenant relief period, the applicable margin may reach 2.5% for SOFR rate loans. The weighted average interest rate on our outstanding borrowings under the Credit Facilities was 7.2% at June 30, 2023. During the term of the revolving credit facility, the Company will pay a commitment fee on the unused portion of the revolving credit facility equal to between 0.125% and 0.250% (depending on the Company’s net leverage ratio). During the covenant relief period, the commitment fee may reach 0.300%. The available balance under the revolving credit facility is reduced by outstanding letters of credit. As of June 30, 2023, there were no outstanding letters of credit under the revolving credit facility.

Contractual principal payments for the term loan are as follows: remainder of 2023 - $1.9 million; 2024 - $4.7 million; 2025 - $5.6 million; 2026 - $6.6 million and 2027 - $52.5 million. The term loan does not contain pre-payment penalties.

The Credit Facilities are secured by substantially all of the operating assets of the Company, and the Company’s obligations under the Credit Facilities are guaranteed by all of its domestic subsidiaries. The Company’s obligations under the Credit Facilities are subject to acceleration upon the occurrence of an event of default as defined in the Credit Agreement. The Credit Agreement contains customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, restricted payments (including dividends and related distributions), liquidations, mergers, consolidations or acquisitions, affiliate transactions and sales of assets or subsidiaries. The Credit Agreement also requires the Company to comply with a fixed charge coverage ratio of at least 1.25 to 1.0 and a net leverage ratio not to exceed 4.0 to 1.0, except during the covenant relief period. The Company’s net leverage ratio (as defined in the Credit Agreement) is generally calculated as the ratio of (a) indebtedness minus unrestricted cash to (b) consolidated EBITDA for the four most recently ended fiscal quarters. As of June 30, 2023, the Company was in compliance with these ratios as the Company’s fixed charge coverage and net leverage ratios were 2.0 to 1.0 and 3.7 to 1.0, respectively.

Dividends and Share Repurchase Program

During the six months ended June 30, 2023 and 2022, the Company paid cash dividends of $4.6 million and $4.2 million, respectively. The Company anticipates that it will continue to pay dividends in the future as financial conditions permit.

On May 2, 2019, the Company’s Board of Directors approved a stock repurchase program of up to 750,000 shares of the Company’s outstanding common stock. There is no expiration date or other restriction governing the period over which the Company can make share repurchases under the program. All purchases under this program will be open market transactions. At June 30, 2023, the Company’s remaining repurchase capacity under its common stock repurchase program was 657,451 shares. Shares purchased under the common stock repurchase program are constructively retired and returned to unissued status. The Company considers several factors in determining when to make share repurchases, including among other things, the cost of equity, the after-tax cost of borrowing, the debt to total capitalization targets and its expected future cash needs.

Critical Accounting Estimates

See Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2022.

Non-GAAP Financial Measure

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

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

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

Interest Rate Risk

We are subject to market risk exposure related to changes in interest rates on our debt. Interest on our Credit Facilities is based upon the secured overnight financing rate (“SOFR”). As SOFR is a relatively new reference rate with a limited history, there may or may not be more volatility than with other reference rates such as LIBOR, which may result in increased borrowing costs for the Company. A hypothetical increase in the SOFR of 100 basis points as of January 1, 2023 would have resulted in approximately $0.7 million in additional pre-tax interest expense for the six months ended June 30, 2023. For further information regarding our debt instruments, see Note 3 to the Financial Statements.

Foreign Currency Exchange Risk

Sales to customers outside of the United States are subject to fluctuations in foreign currency exchange rates, which may negatively impact gross margin realized on our sales. Less than 5% of our sales contracts are denominated in foreign currencies. We cannot predict the effect of exchange rate fluctuations on our operating results. In certain cases, we may enter into foreign currency cash flow hedges to reduce the variability of cash flows associated with our sales and expenses denominated in foreign currency. As of June 30, 2023, we had no foreign currency exchange hedging contracts. There can be no assurance that our strategies will adequately protect our operating results from the effect of exchange rate fluctuations.

Financial results of our foreign subsidiaries in the Branded Products segment are denominated in their local currencies, which include the Hong Kong dollar, the Chinese renminbi, the British pound, the Indian rupee, the Brazilian real, Colombian peso and the Canadian dollar. These operations may also have net assets and liabilities not denominated in their functional currency, which exposes us to changes in foreign currency exchange rates that impact income. Excluding intercompany payables and receivables considered to be long-term investments, changes in exchange rates for assets and liabilities not denominated in their functional currency are reported as foreign currency transaction gains (losses) within selling and administrative expenses in our statements of comprehensive income. During the six months ended June 30, 2023 and 2022, foreign currency losses were not significant. We also have exposure to foreign currency exchange risk from the translation of foreign subsidiaries from the local currency into the U.S. dollar. Comprehensive income during the six months ended June 30, 2023 and 2022 included a foreign currency translation adjustment gain of $0.6 million and $0.1 million, respectively.

Disclosure Controls and Procedures

The Company conducted an evaluation, under supervision and with the participation of the Company’s principal executive officer, Michael Benstock, and the Company’s principal financial officer, Michael Koempel, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report (the “Evaluation Date”). Based on such evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were not effective because of the material weakness in the Company’s internal control over financial reporting described below and as previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

As of December 31, 2022, management identified a material weakness relating to segregation of duties, change management and user access and within certain proprietary information technology systems of the Contact Centers segment. The Company determined that management’s review controls over these areas are not designed effectively to detect a material misstatement related to the completeness, accuracy, and presentation of the financial statements.

Notwithstanding the identified material weakness, management, including the Company’s principal executive officer and principal financial officer, have determined, based on the procedures they have performed, that the consolidated financial statements included in this Form 10-Q present fairly, in all material respects, the Company’s financial condition, results of operations and cash flows at the Evaluation Date, and for the periods presented, in accordance with U.S. GAAP.

Remediation Efforts with Respect to the Material Weakness

The Company’s management, under the oversight of the Audit Committee, has developed a plan to remediate the material weakness relating to certain proprietary information technology systems of the Contact Centers segment identified as of December 31, 2022 which includes the following measures: (i) develop information technology general controls to manage access and program changes within our proprietary system; (ii) implement processes and controls to better identify and manage segregation of duties; and (iii) design and implement additional enhanced review and monitoring controls.

The material weakness will not be considered remediated until management completes the remediation plan above, the enhanced controls operate for a sufficient period of time, and management has concluded, through testing, that the related controls are effective. The Company will monitor the effectiveness of its remediation plan and will refine its remediation plan as appropriate.

Changes in Internal Control over Financial Reporting

Except as discussed above under "Remediation Efforts with Respect to the Material Weakness", there were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

We are exposed to certain risks and uncertainties that could have a material adverse impact on our business, financial condition and operating results. Except as set forth below, there have been no material changes to the Risk Factors described in Part I, Item 1A-Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022.

Adverse developments affecting the financial services industry, including events or concerns involving liquidity, defaults or non-performance by financial institutions or transactional counterparties, could adversely affect our business, results of operations or financial condition.

Events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions, transactional counterparties or other companies in the financial services industry or concerns or rumors about any events of these kinds or other similar risks, have in the past and may in the future lead to market-wide liquidity problems. For example, on March 10, 2023, Silicon Valley Bank (“SVB”) was closed by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (“FDIC”) as receiver; on March 12, 2023, Signature Bank and Silvergate Capital Corp. were each swept into receivership; and on May 1, 2023, First Republic Bank failed and regulators sold substantially all of its assets to JPMorgan Chase & Co. The failure of First Republic Bank occurred despite a previous attempt by some of the nation’s largest banks to shore up First Republic’s capital. Although we assess our banking and customer relationships as we believe necessary or appropriate, our access to funding sources and other credit arrangements in amounts adequate to finance or capitalize our current and projected future business operations could be significantly impacted.

In addition, investor concerns regarding the U.S. or international financial systems could result in less favorable commercial financing terms, including higher interest rates or costs and tighter financial and operating covenants, or systemic limitations on access to credit and liquidity sources, thereby making it more difficult for us to acquire financing on acceptable terms or at all. Any decline in available funding or access to our cash and liquidity resources could, among other risks, adversely impact our ability to meet our operating expenses, financial obligations or other obligations, result in breaches of our contractual obligations or result in violations of federal or state wage and hour laws. Any of these impacts, or any other impacts resulting from the factors described above or other related or similar factors not described above, could have material adverse impacts on our liquidity and our business, results of operations or financial condition.