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Rocky Brands (NASDAQ:RCKY)

Q4 2012 Earnings Call

February 21, 2013 03:00 PM ET

Executives

Brendon Frey - ICR

David Sharp - President and CEO

Jim McDonald - CFO

Analysts

Mitch Kummetz - Robert W. Baird

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands fourth quarter and fiscal 2012 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (Operator Instructions).

I would like to remind everyone that this conference call is being recorded and I would like to turn the conference over to Mr. Brendon Frey of ICR. Thank you Mr. Frey you may begin.

Brendon Frey

Thank you. Before we begin, please note that today’s discussion, including the Q&A period, may contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Such statements are based on information and assumptions available at this time and are subject to change, risks and uncertainties which may cause actual results to differ materially. We assume no obligation to update such statements.

For a complete discussion of the risks and uncertainties, please refer to today’s press release and reports filed with Securities and Exchange Commission, including Rocky’s Form 10-K for the year ended December 31, 2012.

And I’ll now turn the conference over to Mr. David Sharp, President and Chief Executive Officer of Rocky Brands.

David Sharp

Thanks, Brendon. Good afternoon and thanks for joining us. With me on the call is Jim McDonald, our Chief Financial Officer. Fourth quarter proved to be more challenging than we anticipated. The second successive (inaudible) start to winter reduced in-season demand for insulated waterproof boots across our work and hunting categories.

Many retails in the working outdoor channels started 2012 with carryover inventory following last year’s warm and dry winter which they were unable to fully work down throughout the year due to the continuation of unfavorable temperatures. As a result, our atone sales and reorders were below plan in November and December.

Total sales miss-projection by approximately $7 million which had a corresponding impact on net income of roughly $1.5 million, due to the relatively small number of outstanding shares, our modest top line (inaudible) have a substantial impact on our earnings per share and that’s what happened in the fourth quarter.

Weather has always played a role in Rocky Brands fortune. A 2005 acquisition of EJ Footwear significantly reduced the company’s reliance on cold wet hunting seasons.

Since the acquisition, we have taken steps to organically diversify our operations further indicate the impact of weather on our results.

Work on this diversification is focused primarily on Durango, leveraging the brand’s authenticity and popularity to product line extensions for women and children and expanding beyond western into more mainstream lifestyle collections.

In the past two years we've introduced several new products with good success including more fashion forward boots that opened up new distribution and expanded our presence with existing accounts. The response to Durango’s 2012 products offering was extremely positive, with total brand sales up 44% for the year. Importantly, the strength was broad based as both in line and new styles performed very well with most major customers. For 2013, we hope to maintain current momentum with the brand of retail. We are again introducing many new programs.

The other area of our wholesale business that helped offset declines related to weather is commercial military. For the year, sales under the Rocky brands increased 8%. This was driven by a popular S2V product service, more recently the introduction of our light weight C4T Garrison training boots.

With regards to S2V demand, we did experience the slowdown in Q4 as the looming Federal Government mandated sequestration budget cuts, dampened market after type for additional inventory. While we believe this to be a temporary issue, sales of S2V are likely to remain soft for at least first half of 2013 until the overhang of fiscal cliff is behind us.

That said, demand for C4T has not waned because most of them are purchased by the soldiers on base to and moving quickly to fulfill orders and expand distribution within the TX channel.

Now for our retail division, as you know, over the past few years, we have transformed it into a more nimble organization by utilizing a lower cost web based order platform and direct ship model. There are a number of notable achievements in 2012 that highlights success of this multi-year initiative.

First, we ended the year with 71% of all transactions being executed via the web up from 59% at year-end in 2011. Second, the division’s profit contribution increased more than 50% despite the 8% drop in sales, underscoring the enhanced profitability of the new model.

Lastly, fourth quarter sales decreased versus the year ago period, indicating that the drop in top line precipitated by the removal of 80% of our mobile stores over the past four years, hit trough levels and is now on an upward trajectory.

Jim will now go through the financials in detail and then I will return to discuss the key growth drives of 2013. After that we will be happy to take questions.

Jim McDonald

Thanks David, before I begin I want to remind everyone that last year's fourth quarter results included a onetime non-operational charge of $3.7 million net of tax associated with the termination of our device benefit pension plan. The year-over-year comparisons in my discussion exclude the impact of the aforementioned charge. For reconciliation to our GAAP results, please see the table that accompanies today's announcement which is available on our website of rockybrands.com.

Now to our results, net sales for the fourth quarter were $58 million compared to $64 million for the corresponding period a year ago. Wholesale sales for the fourth quarter were $46 million compared to $51.7 million last year. We've experience significant growth with our Durango brand which posted a 48% increase. This was offset by declines in our hunting commercial military and both categories, which decreased 27%, 25% and 17% respectively.

Retail sales for the fourth quarter increased to $12 million compared to $11.8 million a year ago. And there were no military segment cells versus $400,000 for the same period in 2011. Gross profit in the fourth quarter was $20.7 million or 35.7% of sales compared to a $22.5 million or 35.1% of sales for the same period last year. The 60 basis point increase in our gross margin was driven by higher margins in our retail business.

Selling general administering expenses were $16.8 million or 28.9% of net sales for the fourth quarter of 2012 compared to $16.7 million or 26.2% of net sales a year ago. Income from operation was $3.9 million or 6.8% of net sales compared to $5.7 million or 8.9% of net sales in the prior year period. For the fourth quarter, interest expense was 200,000 flat with last year. Our effected tax rate for the fourth quarter of 2012 was 31.8% compared to 29.4% in the fourth quarter of 2011.

The higher effective tax rate was a result of pure permanent investments in our Dominican operations in a year ago. We reported net incomes of $2.5 million or $0.34 per diluted share versus net income of $3.9 million or $0.52 per diluted share, last year.

Turning to the balance sheet, our funded debt of December 31, 2012 was $23.5 million a decrease of 33% from $35 million of December 31, 2011.

Inventory at December 31, 2012 was $67.2 million compared with $65 million on the same date a year ago.

David will now discuss the key growth drivers for 2013.

David Sharp

Thank you, Jim. We started 2013 with solid momentum in the Durango brand which along with other new growth initiatives namely our introduction of footwear for healthcare professionals and our introduction of footwear and power for the extreme outdoors enthusiast has us well positioned with the solid top line gain in the first half of the year and further mitigate the impact of weather on our performance.

Building on the successful introductions from 2012, our upcoming product pipeline has several programs that we believe will continue to extend Durango’s leading position in western boots and facilitate further expansion of our fast growing wide stock collections and continue sales momentum.

For example, Cavenders the Tyler, Texas-based premium western boot chain where we grew sales 40% last year on the strength of these additional programs they have expanded their assortment by an additional 12,000 for 2013.

Country Outfitters, the fastest growing online western player, where our sales increased tenfold last year to exceed $1 million has forecasted the Durango line to grow by 25% this year.

Outside of the western channel, we anticipate significant growth with Durango at BSW, Shoe Show and at zappos.com. On the strength of our Durango brand, where we have the same sales force, we are also expecting Rocky brand western sales to improve next year where we have developed new lightweight western work boots.

In addition to continue growth from our western lifestyle categories, we will be generating additional revenue from a new private label program with attractive supply. The largest retail farmer ranch chain in the U.S. in line with our biggest wholesale partners, under the agreement we’re supplying seven styles to all 1,193 of their doors with the majority of initial pipeline still shipping in the first quarter.

We expect this to be a steady business going forward given tractor supplies national reach and merchandizing capabilities which should help smooth out some of the seasonality in our overall business.

We’re also very pleased to announce that we recently received an order from the U.S. Military to provide the army with hot weather combat boots. It's a five year deal consisting of guaranteed first year followed by four option years. Each year has a minimum purchase amount of 49,000 pairs or roughly $3 million and a maximum of 254,000 pairs or $15 million. Delivery of product will begin next month and we anticipate sales this year to be at the high end of the allowable range. This contract will also help us set some of the declines we've experienced in the more weather sensitive areas of our business.

We believe the majority of our retailers ended 2012 with clean and inventory levels than they did the year before. With temperatures in many areas of the U.S. turning colder in January along with a fair amount of snowfall, sell through has likely accelerated further depleting the headstock positions. We think it's prudent to adopt a cautious outlook with respect to the back half of the year at this point, given the uncertainty around weather and retailer appetite for cold weather products. However should we experience a fall in winter season more typical than the past two years there is likely upside to our internal forecasts.

On the product cost side of the business, things are moving in our favor to start the year. As the result of increased utilization of our company owns production facility in the Dominican Republic during the third and fourth quarter of 2012, product margins will be up in the first half of 2013, over the same period last year.

So our outlook for the first half of 2013 is as follows. Based on the growth initiatives we discussed we anticipate sales to improve approximately 12%. We anticipate gross margins to improve by a 125 basis points as a result of product cost reductions and as a result of increased investments in growth initiatives and the variable expenses associated with additional sales, we anticipate SG&A to increase by 10%. As we get further along in the year and gain more visibility into the back half sales trends we will update you on our full year outlook.

I want to close today's prepared remarks by thanking everyone at Rocky Brands for a true team effort in 2012. The combined strength of this organization allow us to navigate through a challenging operating environment late in the year and emerge in a solid position to regain a momentum and drive improved results in 2013.

Operator we're now happy to answer your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen at this time, we will be conducting a question-and-answer session. (Operator Instructions). Our first question comes from the line of Mitch Kummetz from Robert W. Baird. Please proceed with your question.

Mitch Kummetz - Robert W. Baird

David, I know at this point you are reluctant to give a back half outlook but given maybe the limited visibility that you have, I mean at this point, are you anticipating that sales and margins will be down in the back half just as retailers are very cautious on you know pre-booking cold weather products based on another mild winter season, this past season, is that how you are thinking about it?

David Sharp

No, Mitch, we are not that pessimistic. I think that we got some visibility into the hunting as the heavily insulated work products and we are ahead of the bookings that we had last year. We think that retail is certainly ended with less inventory in their stocks than they ended the prior year. Also, we are very optimistic about this western business of course a lot of that ships in the third and fourth quarter.

And we do have the (inaudible) business, the private label business that just see, that of course is the year around program and the military business also into the third and fourth quarters. We'll also be shipping beginning in May and June the healthcare products. Our bookings are ahead of our expectations at this point and we have a lot of optimism for that program in third and fourth quarters.

Mitch Kummetz - Robert W. Baird

Okay, that’s actually very helpful but again as I am trying to frame this and work it through my model, should I then assume that these sales and margins aren't up as much in the second half or the first half because you have some headwinds on something in work?

David Sharp

Yes. I think that’s right.

Mitch Kummetz - Robert W. Baird

That’s great and then I just want to drill down a little bit more on a couple of these businesses. So you mentioned the strength of Durango and then Western in general, can you just give us, provide some context behind that, how big is either Durango or your overall western business right now and what type of growth rate are you anticipating in 2013 on that business and to what extent are you seeing the new accounts coming in the fold on that business?

David Sharp

Well specifically Durango, we ended Durango in about 25million, 26 million, and the Rocky Western portion is about 40 million and we are modeling a 25% sales increase with Durango for 2013.

Mitch Kummetz - Robert W. Baird

Okay, and then on the new tractor supply private label contracts, it sounds like you'll benefit from Channel sale in the first quarter. But do you have anything in numbers you can put to that business in terms of your outlook for 2013?

David Sharp

We have that modeled at around $8 million to $10 million.

Mitch Kummetz - Robert W. Baird

Okay, all right, and then maybe lastly, on the state military contract, if I heard you correctly you said that you expected to be towards the high end or at the high end, I think the high end was $15 million on the year, what’s the high end on that? Or what’s your expectation for this military contract could contribute to 2013 revenues?

David Sharp

Yes, the high end, it could be $12 million, so about a $15 million annual but, we are not getting started, we are not starting shipping until February.

Mitch Kummetz - Robert W. Baird

So again you’re thinking you wanted that to be around 12 million?

David Sharp

That’s right.

Mitch Kummetz - Robert W. Baird

That’s great to hear. That’s it, and I appreciate it, good luck

Operator

(Operator Instructions) There are no further questions. We do have another question coming from the like of Mitch Kummetz, please proceed with your question.

Mitch Kummetz - Robert W. Baird

Let me just, one last thing, just in terms of, maybe two last things; in terms of margins you said that there will be a lot of moving pieces here, these different business have different margin structures. So if we think about like gross margin on the year, I know that in terms of tractor, the private label and military, those are lower gross margin businesses, so how should we think about gross margins as they play out through the year, and then also I guess on SG&A, Jim, you guys were I think you were down on SG&A for 2012, I think you are sort of fairly flat in the quarter, if I am not mistaken, so how should we, so how should we think that, does that build especially if you have some of these newer programs, just like the healthcare piece, just a little help on that will be great.

David Sharp

Yes, I think the large, take it out to tractors supply for a wholesale. I think those margins will be up based on the reduced product cost. Not as much in the second half of the year certainly as they were in the first half of the year, so up slightly in the second half of the year. And then the tractors margins are in the mid-teens on those mid to upper teens, so that's what I would factor on that and then the military is our traditional margins are about 12 to 13%.

And I think the retail margins, it where they are going to be now as we have moved in almost all the last business over to the, that has lower gross margins but higher operating margins from this new platform that we have so. On the SG&A, we are as we said, we are planning the SG&A up. Looking at the increase in sales you would look at about 15% on that for the variable portion of it. But we are also having some increases in our investments in advertising and selling expenses for our new endeavors and some additional sales people. And then the other thing is we made some significant investments as we've installed the new ERP over the last couple of years here that were starting to have to recognize depreciation on that. So we are going to have some additional depreciation about $1 million year-over-year that will be with SG&A so. Between that additional investments of the advertising and the depreciating, we are probably talking probably about $3 million and then the variable, so that’s $3 to $4 million of additional SG&A.

Mitch Kummetz - Robert W. Baird

Okay, so what were the segment gross margins through the quarter?

David Sharp

Yes the wholesale was 32.6% and the retail was 47.4% and that being military sales in the quarter.

Mitch Kummetz - Robert W. Baird

And I have one last thing, on the retail business, David you mentioned that through the first quarter in a where that business will actually up a little bit so It sounds like the sales have dropped in terms of your transition there so I mean at this point, are you basically done with your transition and you think that the sales can be sort of flat to upwardly go forward in that business?

David Sharp

Yes, we projected them up mid-single digits for this year.

Mitch Kummetz - Robert W. Baird

Okay and again does that imply that you basically done with the transition or just still little bit of work to be done yet?

David Sharp

There is still little bit of work to be done yet. I think the other think (inaudible) in there we’re expanding our B to C business so that’s in our retail segment, so that’s why you’re starting to see the sale helped to offset any further decline in the high business.

Operator

There are no further questions in the queue. I would like to turn the call back over Mr. Sharp for closing comments.

David Sharp

Well, thank you. Thank you for listening and we’ll continue to work hard to deliver a strong first half of 2013, thanks.

Operator

Ladies and gentleman, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.

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