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Rocky Brands, Inc. (NASDAQ:RCKY)

Q1 2009 Earnings Call

April 28, 2009, 4:30 pm ET

Executives

Brendon Frey - IR, ICR

Mike Brooks - Chairman and CEO

David Sharp - President and COO

Jim McDonald - EVP and CFO

Analysts

Reed Anderson - D. A. Davidson

Kevin Kim - Robert W. Baird

Peter Larson - Columbia Management Group

Operator

Welcome to the Rocky Brands Fiscal 2009 First Quarter 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 remind everyone that this conference call is being recorded.

I will now like to turn the conference over to Brendon Frey of ICR.

Brendon Frey

Thanks. 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 the Securities and Exchange Commission, including Rocky's Form 10-K for the year ended December 31, 2008.

I will now turn the conference over to Mr. Mike Brooks, Chairman and Chief Executive Officer of Rocky Brands.

Mike Brooks

Thank you, Brendon, and thank you everyone for joining us this afternoon to review our first quarter results. With me on today's call are David Sharp, our President and Chief Operating Officer, and Jim McDonald, our Chief Financial Officer and Treasurer.

Our first quarter results were generally inline with our internal projections. We expect sales and earnings to be down from a year ago as we were up against tough comparisons in our retail division and higher than normal gross margins in the first quarter of 2008, which we were unable to anniversary. Our top line was also impacted by lower than anticipated wholesales sales primarily in our work in western segment.

As the difficult economic environment continues or more of our retail partners of cut back from the size and frequently of their orders and chosen to operate with leaner and stock position until the market condition improved. We have been doing business with majority of our account base for many years and everyone understands where all of in this together because of this longstanding relationships and confident we will continue to work successfully with then to help offset risk and maximize productivity.

Importantly, we continue to focus on areas of our business that we can directly control namely expenses and one again we did a very good job managing cost down in conjunction with lower sales volumes. That included reductions in salaries and benefits, advertising expenses, sales commissions which contributed to 13.5% or $3.1 million decline in SG&A versus last year. Our SG&A was also down due to our ongoing efforts to drive more of our Lehigh safety shoe business to the web.

While we are still in early stages of executing the strategy we are pleased by our initial success of transitioning a greater percentage of the transactions over the internet which is always, which has always used to reduce cost associated with operating our Lehigh mobile stores. We would expect this trend to continue as the year progresses.

While we have not seen any clear sign that the recession is ending, or we predicting when it will happen. However, there are few factors specific to the business that have us cautiously optimistic about our prospects in the back half of this year.

First a year-over-year comparisons begin to moderate beginning with the third quarter, in addition we have started to see a shift in our sales bag to more of a Q3 and Q4 timeframe. Prior to our acquisition of EJ in early 2005, our sales and earnings were heavily concentrated in the third quarter. With the addition of work in western footwear our sales became much more evenly distributed through all four quarters. While we don’t expect that to be so heavily depended on the third quarter, the shift in retail buying patterns is indicating that the greater percentage of our overall business will now occur between approximately June and November. And with a large portion of our costs fixed we would therefore expect expenditures greater operating expense leverage during this period.

Second, we have seen a very nice response to our new hunting and work footwear, particularly from several of our major accounts. And that is reflected in a solid increase in our backlog could fall.

Third, we recently signed a distribution agreement for Rocky Hunting footwear and apparel with Garlands one of the premiere hunting distributors in the UK. They covered England, Garden Wales and Northern Ireland. We expect to begin to shipping them product beginning this fall and along with our distribution in Eastern Europe, international sales should be meaningful version this year.

Finally we would expect to gain some incremental business as a result of the multiple spending programs recently announced by the Federal Government. As you know, a large portion of the $750 billion stimulus bill is dedicated to rebuilding the company’s infrastructure namely bridges and roads.

This will put a significant amount of people to work who will need to work and safety footwear. Though either through our direct retail operations or through our wholesale account we do anticipate capitalizing a portion of this business portion of this business beginning this summer.

I will now turn the call over to David who will review each of our operating segments in more detail.

David Sharp

Thanks Mike. I would like to talk about our retail division first because this is where our business has been most challenged. As you know the company took steps in the fourth quarter to remake our retail business.

Our plan now is to offer our industrial and hospitality customers provide their workers with safety footwear better economic proposition. Customers may now opt to purchase via custom websites as opposed to what's driving trucks containing inventory and bidding employees in their workplace a very costly in way to transact business. The new model is resonating well with our customers and our cost savings story is particularly relevant in this economic downturn.

In events of fully implementing this new model we chose to strategically downsize our fleet of mobile trucks particularly in locations where operating profits were marginal and to benefit from reduced expenses.

Knowing full well that our sales would be negatively impacted until the new strategy is fully leveraged. As Mike highlighted, our expense reductions in the first quarter was substantial, and the downsizing of our mobile fleet operations contributed to this reduction significantly.

In addition, we did not yet fully realize all of the cost reduction benefit because we incurred one-time severance in store closing in first quarter.

So, first quarter sales in our retail division was $13.7 million versus $18.9 million the year before. In the quarter, we saw many customers defer their purchases due to cut backs of their facilities. However, we are very encouraged by the response to our new model.

In the quarter, we set up 1300 accounts with fully customized websites. We expect more and more customers to convert the web as they and are sales force become comfortable with the model.

Now, turning to our wholesale division, for the first quarter our sales were $36 million compared to $39.7 million in the corresponding period a year ago. Within our work category which includes footwear under our own brand Georgia and Rocky, and our license brands, Dickies and Michelin, sales were $18.5 million in the first quarter compared with $22 million in the prior year period.

During the first quarter, the major portion of the sales in this category is driven by the retailers filling into their basic inventory model. We saw retailers reduce these models during the quarter in response to economic conditions, hence the lower sales.

Additionally, we have a major accounts change their merchandising force which effectively stalled their shipments for them in first quarter and caused a decrease of $900,000. Fall of goods to this account is now resolved.

Now turning to our western category, first quarter sales were off 10%. They were $7.2 million versus $8 million a year ago. As you were aware last year we struggled with supply issues as we resulted with the major supply for this category.

We are now sourcing this category from three new suppliers and have an adequate supply and inventory and we are properly prepared to fully realized sales potential of the category when the economy begins to recover. That's our bright spot.

Sales of our duty footwear in the first quarter were $5.3 million compared to $3.8 million a year ago an increase of nearly 40%. Although this businesses for the most part conducted in the public sector and has not been impacted by the economy like other businesses. We also pleased because of our commitment to innovation that we continue to win over new customers everyday in this category.

Federal, state and local law enforcement procurement offices are increasingly enamored with our product as such they will specify the Rocky Brands when they outfit their workers.

Finally, before I turn the call on to Jim I just want to punctuate two points that Mike touched on earlier. First early last year we made the decision to multiply our assets and new product development and innovation.

Successful implementation of decision is evident in our order backlog to fall, where we will be first delivering this new product. All categories work less than duty were encouraged by growing backlog of orders for new products.

Second, for the past 18 months we have been focused on building distribution the Rocky Brand beyond North America. Had great success in Europe. We now have multiyear distribution agreement which contain performance criteria with four large established tuck-in good distributors. We now have representation in 28 European countries the Rocky hunting footwear and apparel.

Now we are turning our efforts to improve focus on our western product line in the Durango brand.

I will now turn the call over to Jim, who will review the financials, Jim?

Jim McDonald

Thanks, David. Net sales for the first quarter decreased 17.2% to $50.1 million, compared to $60.5 million for the corresponding period a year ago. Gross profit in the first quarter was $20.1 million, or 40.1% of sale compared to $25.9 million, or 42.9% of sale for the same period last year.

The 280 basis point decrease in gross margin was primarily attributable to lower retail sale, which carry a higher gross margin and to a lesser extent lower wholesale gross margins due to increased manufacturing cost versus the year ago.

Selling, general and administrative expenses decreased 13.5%, or $3.1 million, to $19.9 million, or 39.8% of sales for the first quarter of 2009 compared to $23.1 million, or 38.1% of sales a year ago. The decrease in SG&A expenses is primarily the result of reductions in salaries and benefits, advertising, freight, professional fees and Lehigh mobile store expense.

Income from operations was $0.1 million, or 0.3% of net sales for the first quarter of 2009 compared to income from operations of $2.9 million, or 4.8% of net sales for the first quarter of 2008.

Interest expense for the first quarter decreased 26.3%, or to $1.8 million from $2.4 million in the first quarter of 2008 as a result of lower borrowings under our credit facility combined with lower interest rates compared to the same period last year.

For the quarter, we reported a net loss of $1.1 million, or $0.20 per diluted share in the first quarter of 2009 compare to net income of $0.3 million, or $0.05 per diluted share in the first quarter of 2008. Inventory decreased $1.4 million to $78.4 million at March 31, 2009 compare to $79.8 million on the same date a year ago. Funded debt as of March 31, 2009 decreased 8.4%, or $7.9 million to $86.2 million compared to $94.1 million at March 31, 2008.

As a reminder, on March 31st, we announced that we amended our credit facility with GMAC Commercial Finance, LLC to extend the facility's maturity through April 30, 2012. The credit facility was originally scheduled to mature on January 5, 2010. In addition, the amendment reduced the commitment under the facility from $100 million to $85 million. As of March 31, 2009, we had $46.2 million outstanding on the line.

I will now turn the call back to Mike for some closing comments.

Mike Brooks

Thanks Jim. While I do believe there are still challenging times ahead of us, I do think that the worst of this recession is now behind us. Looking out at the remainder of 2009, our sales comparison, they are beginning to moderate, particularly starting in July and we should see of incremental business driven by the stimulus spending.

We expect gross margin be roughly flat versus last year nine-month of 2008, and SG&A to be down over the same nine months period of last year. Although not at the same rate it was in the first quarter. We are also forecasting that our debt levels will come down further by year end.

Our entire team continue to do a very good job managing our business through this volatile environment, and I believe we are well positioned to capitalize on the market share opportunities that will materialize when the economy improves.

Operator, we will now be ready to take any questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) The first question is from Reed Anderson with D. A. Davidson. Please go ahead with your question.

Reed Anderson - D. A. Davidson

Good afternoon. Mike, I was curious, how are you feeling in terms of pricing in this environment, have you been able to kind of maintain kind of pricing integrity, are you feeling pressure to offer little incentive, what's your thought on pricing at this point?

Mike Brooks

Reed, we are fortunate that we have multiple brand, and we have price segment of those brand, and we have not had price pressures that we have reduced our wholesale selling price, we are generating some interest through freight from time-to-time and some additional incentives, some in-store marketing, but we have not felt to need to break price.

And if that is your question, and especially with the new product that we are offering that they have signed up for and our backlog is, started in the second half over last year, there is nothing price pressure. David may be you have something.

David Sharp

At the end of this year we took about a 1.5%, 2% price increase.

Reed Anderson - D. A. Davidson

Okay.

David Sharp

And our retail customer seems to be settled into that pretty well.

Reed Anderson - D. A. Davidson

That’s good. And then in terms of the other side of that the cost side, is your sense that maybe later as this year moves on you might see a little benefit on the cost side of things or is too early to tell.

David Sharp

Well.

Reed Anderson - D. A. Davidson

I am talking about ending up the souring production not the SG&A side. I am sorry.

David Sharp

Yes I understand the question and, a year ago there was inflation with the cost side almost runaway inflation that’s been reversed and factories are not full. And there are some opportunities not break, but there are some opportunities or volume orders so we are trying to take advantage of that.

Reed Anderson - D. A. Davidson

Okay. And then you talked a little bit about trend, the early stages of migrating some of the Lehigh business to the web and that sort of thing, so you've gotten lot of people looking at that. What's the thinking there in terms of to provide them an incentive whether it’s a volume discount, or is that where the freight piece comes in, how would we think about the benefits of the customer. How would you position that?

David Sharp

Sales proposition is all around cost savings. And what we are showing customers is if they go to the web and this amount to 15% to 25% cost savings.

Reed Anderson - D. A. Davidson

Okay.

David Sharp

And we are selling that to the management that will keep those cost savings and all have it their heart to break, but we think once management feels the cost savings in today’s environment they almost cannot break down.

Reed Anderson - D. A. Davidson

Okay good and lastly on Lehigh could you give an order of magnitude of either number of trucks that are down, you talked about a lot of how did you make big progress. I am just curious what that equates to in actual numbers?

David Sharp

We are currently operating with about 65 trucks which is now down about 20 from December of last year.

Reed Anderson - D. A. Davidson

Okay great that’s it for me. Good luck thanks.

David Sharp

Thanks.

Operator

The next question is from Mitch Kummetz with Robert W. Baird. Please go ahead with your questions.

Kevin Kim - Robert W. Baird

Hi guys this is actually [Kevin Kim] calling in for Mitch.

Mike Brooks

Hi Kevin

Kevin Kim - Robert W. Baird

Hi Mike, I just had a quick question as far as genuine Dickies and launch of Wal-Mart I know that you guys were working through some of the issues when you guys reported Q4, can you give us an update on that maybe total doors and total skews and kind of how that’s being going so far?

Mike Brooks

Kevin you are correct. Year-end last year we talked about a start late last year late November and not a good distribution of the product in the stores. The answer is there has been more of the same. Our customer Wal-Mart has moved the buying headquarters from [Westville] to New York just two weeks ago they designed a buyer a footwear buyer we were there last week. And then we have got good information that they are going to test lower price points and they are going to test location in the footwear department and are going to distribute into I think they made ahead of wrong stores instead of we were in many of the wrong door. So, we don’t have a strong answer for you other than we got a new manager, a new buyer and actually it's open to ideas to regenerate sale interest in the brand.

Kevin Kim - Robert W. Baird

Okay. And then as far as guidance, realizing you guys are not providing official guidance, but given all the positive things that you guys were talking about, that could hid in the second half weather it's federal spending, or this new UK or the backlog increase. Would you guys go as far as to say that you guys are expecting top line growth in the second half of '09?

Jim McDonald

Kevin, this is Jim, I think that as Mike said in his closing comments, we feel like the gross margins are going to be flattish with what they were last year in the last nine months of the year. And we feel SG&A is going to be down year-over-year and although it may not as significantly as it was in the first quarter, but certainly down year-over-year. You know, the biggest question is the top line and we feel as we move to back half of the year, the comparison become easier because our business was down more particularly on our retail business in the back half of the year. So, we certainly have a greater opportunity to equal our last year as we move forward to the next nine months. That’s obviously everybody's $400,000 question is what the sales look like at the back half.

Kevin Kim - Robert W. Baird

Exactly the stuff right now. And then, as far as this backlog increase that you guys are experiencing in the second half, can you guys quantify that in a specific way, I think, David you mentioned in categories.

David Sharp

I don't just want to do that, but I can tell you that our business in outdoor around these new products is up substantially in our business some of the key retailers and we are experiencing the same kind of reception to our work in western product. But traditionally you do not have quite the profit in the third quarter on, so we are very optimistic about what we see and brought back in the for the back half of the year.

Kevin Kim - Robert W. Baird

Okay. Now that's great to hear.

Mike Brooks

We have those orders in house so we know what those numbers are but we are, as compared to last year we know where our new business is coming from and as we brought play out.

Kevin Kim - Robert W. Baird

Okay. And that's it for me. Thank you so much.

David Sharp

Thanks, Jeff.

Operator

(Operator Instructions) The next question is from Peter Larson with Columbia Management Group. Please state your question.

Peter Larson - Columbia Management Group

Hello all.

Mike Brooks

Hi, Peter.

Peter Larson - Columbia Management Group

Just a couple of things anything from the military that you might be waiting on a decision or have some potential for being there little ways out?

Mike Brooks

Peter, there is two answers to that question. Part of the increase that we saw that David talked about in our duty line is actually, it's a branded military special boot that we had in the line now for couple of seasons, high priced and delivering margin in sales and so that's actually military that's a positive.

The negative is the business is very, very difficult and we were just in, we were just over a public defense last Friday, there is a bid that was still waiting to go from that we bid, the middle of last year and here we are almost one year and they have not left the bid. Now they did indicate that they are going to give everyone another opportunity to readjust their bid. So I do not have anything positive to report with that a couple little contracts that we are working through and we need a sizable contract public defense of where that we verbalize it and that we are really just sitting and waiting like everyone else.

Peter Larson - Columbia Management Group

Okay so I guess, I was looking at military is just giving you little extra and helps in total term of the cost?

Mike Brooks

We see that also and that’s important to us now. One thing I will backup and there is other branded boot is also built in our same plant, it’s a Make in USA product therefore falls in the various complaints. But those are in hundreds of thousands that's probably 30,000 per unit annually but a really good margin to price it.

Peter Larson - Columbia Management Group

Is Long foot ever going to mean much to you guys?

Mike Brooks

We have passed on input. We have trying to build that and we announced that the last quarter for you and basically we were investing money that try to build the long terms and when just so to answer your question no.

Peter Larson - Columbia Management Group

Okay, now I assume that you mentioned that you expected to pay down debt further, I assume that means you expect over the next several quarters to have again free cash and the target for that is going to be pay down debt?

Mike Brooks

That’s correct. And the which we have done the last two years we will continue to do that. I think we have can take some inventory out, more inventory ran a little tighter and watching that inventory everyday.

And we are also trying to limit our capital expenditures as much as possible to build more cash push against the. But the Peter, also our business is we get orders day we shift it tomorrow. We don’t have a, except the fall business David Sharp talked about with our order book. We have to have inventory to service our customer. So, I do not want to mislead anybody and tell you that we are going to run down inventory. So that we can shape our customers. We got to balanced that.

Peter Larson - Columbia Management Group

No, I am actually interested in your debt getting paid down some and using free cash in that all mode some?

Mike Brooks

So am I.

Peter Larson - Columbia Management Group

I can imagine. I was on your neck yesterday saw I was unable get in there.

Mike Brooks

We should stop.

Peter Larson - Columbia Management Group

Plain just didn’t work. Anyway thanks for the answers, and let's hope things get better for everybody.

Mike Brooks

Thanks, Peter.

Peter Larson - Columbia Management Group

Yeah.

Operator

(Operator Instructions) I am showing no further questions in queue. I would like to turn the call back over to management.

Brendon Frey

Great. Well, thank you ladies and gentlemen for listening, we appreciate the questions, and we look forward to talking to you next quarter.

Operator

This concludes the teleconference. You may disconnect your lines. Thank you for your participation.

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Source: Rocky Brands, Inc., Q1 2009 Earnings Call Transcript
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