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Rocky Brands (NASDAQ:RCKY)

Q1 2013 Earnings Call

April 23, 2013, 4:30 p.m. ET

Executives

Brendon Frey – ICR

David Sharp - President and CEO

Jim McDonald - CFO

Analysts

Mitch Kummetz - Robert W. Baird

John Sullivan – Olsten Capital

Operator

Good afternoon Ladies and Gentlemen and thank you for standing by. Welcome to the Rocky Brands first quarter fiscal 2013 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 will not turn the conference over to Brendon Frey of ICR.

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 at the Securities and Exchange Commission including Rocky's form 10-K for the year ended December 31st, 2012.

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. Thanks for joining us. With me on the call is Jim McDonald, our Chief Financial Officer.

Overall, we are pleased with our start for the year. From a sales perspective, first quarter trends were similar to those we experienced in our brand of business during the back half of 2012. That is, strong demand for the Durango brand helped to offset softness in our working commercial military categories.

Also, contributing to our topline performance in the quarter were initial shipments of our new private label program, the Tractor Supply Company, and our first sales under the new military contract we signed earlier this year.

What's especially gratifying from the first quarter is the 100 basis points improvements in gross margin versus a year ago. This came primarily from improved efficiencies in our company-operated facilities in the Caribbean basin, which are being utilized to produce our private label and military footwear. As a result, we were able to translate a modest sales gain into a 20% improvement in diluted earnings per share.

Digging into our category results, Weston was obviously the stand out, fueled by the performance of Durango as well as gains in the Rocky Brand of Weston category. In total, Weston sales increased 40% compared with last year.

New product introductions have helped increase productivity at traditional Weston and farm and ranch customers. And they have also helped us gain traction in new brick and mortar and e-commerce channels. We're seeing many of our existing accounts go much broader with the brand than before. For example, at Zappos.com, the number of styles we have booked with them this year have increased by 39% versus the same period last year.

The Durango Rebel collections have been very well received this spring with strong selling being followed by strong sell-through at both national and independent accounts. A special edition U.S. flag boot, a new FFA boot, and our Susan B. Komen product also generated a good deal of new business in the first quarter, which has led to replenishment orders early in Q2.

Meanwhile, our Durango Lifestyle collections continue to gain valuable shelf space with key retail accounts. This is Acumen Brands, Shoe Show and Rack Room, thanks to compelling new styles meant to attract consumers with a more urban fashion sensibility. We expect this trend to continue as the year progresses and we bring more styles to market including moccasins this fall, the brand's first non-boot collection.

We'll continue to attempt to capitalize on the momentum of our Durango brand. Later this year, we'll conduct tests in certain markets with leather apparel and accessories. And for spring '14, we'll test sandals.

Turning to our work category, sales from our new private label program with the Tractor Supply Company were offset by declines in their Georgia Boot business. We were up against tough comparisons from the TSC store expansion program initiated in the first quarter of 2012.

Following a cold spring in which sell-through improved versus the last few quarters, bookings have started to accelerate again, setting the category up for improved results starting in the back half of the year.

Similarly, bookings for Rocky Outdoor are up meaningfully as retailers prepare to restock their shelves ahead of the fall season.

While Q1 sales were down year-over-year, the decline was mainly due to lower closeout sales, but we didn’t have an anniversary due to the lack of closeout inventory. After back-to-back mild winters, I believe the channel is now relatively clean. And our full price business is poised to grow in 2013.

During the first quarter, we experienced a nice lift in sales of both our work and outdoor apparel. We recently signed a licensing agreement for the Rocky Brand with Intradeco, a global manufacturer of underwear that supplies 50% of the thermal products sold in the U.S. market and is a main supplier to Wal-Mart. We believe this arrangement is the optimal way to manage this business as it provides a steady royalty income with no inventory risk.

Finally, commercial military sales remain under pressure as buyers were cautious ahead of the mandated federal budget cuts that went into effect on March 1st. This mainly impacted demand for our popular S2V products.

On a more positive note, demand for our lightweight Garrison training boot remains solid. We're making steady progress expanding both our product offering and points of distribution.

Now to our retail division. Sales were up year-over-year for the second consecutive quarter since we committed to transforming this business model two years ago. We've made great progress transitioning the majority of our Lehigh business-to-business operations to the web. Now 74% of all B2B sales are through web or catalog versus 71% in the previous quarter and 59% for the same period a year ago. We ended the quarter operating 16 trucks versus 28 a year ago.

We're also making great strides in our business through the web direct to consumer. Orders on our Rocky, Georgia, and Durango sites are up 87% for the period versus the same period a year ago. Suddenly, increased focus on pay-per-click, search engine optimization and social media campaigns are having a positive effect. And we are also adding product-specific videos to each site, which is really improving conversion of visits to sales.

As we continue to improve our retail business and with strong and building momentum in the Durango brand and our work and outdoor categories positioned for improved back-half performances and shipments of military footwear increasing, we are cautiously optimistic we can deliver enhanced top-line results over the remainder of the year.

With that, I'll turn the call over to Jim to review the financials. Then we'll be happy to take your questions.

Jim McDonald

Thanks, David.

Net sales for the first quarter were $53.7 million compared to $53.3 million for the corresponding period a year ago. Wholesale sales for the first quarter were $42 million compared to $42.4 million last year. We experienced significant growth with our Durango brand, which posted a 40% increase in the first quarter. This was offset by declines in our work and commercial military categories, which decreased 6.2% and 30.1% respectively.

Retail sales for the first quarter increased to $10.8 million compared to $10.5 million a year ago. Military segment sales were $900,000 compared to $400,000 for the same period in 2012.

Gross profit in the first quarter was $18.7 million or 34.8% of sales compared to $18 million or 33.8% of sales for the same period last year. The 100 basis point increase in our gross margin was driven primarily by improved manufacturing efficiencies in our company operated facilities.

On a segment basis, we expect gross margin to improve again in the second quarter, although not to the magnitude it did in the first quarter and it to be relatively flat year-over-year during the third and fourth quarters.

Selling, general, and administrative expenses were $17.2 million or 32% of net sales for the first quarter of 2013 compared to $16.7 million or 31.4% of net sales a year ago. The $500,000 increase in SG&A was attributable to higher freight expense primarily related to the gain in our business to consumer e-commerce sales compared with a year ago.

Income from operations was $1.5 million or 2.8% of net sales compared to $1.3 million or 2.4% of net sales in the prior year period.

Our effective tax rate for the first quarter of 2013 was 35% compared to 36% in the first quarter of 2012.

We reported net income of $0.9 million or $0.12 per diluted share versus net income of $0.7 million or $0.10 per diluted share.

Turning to the balance sheet, our funded debt at March 31st, 2013 was $20.3 million, a decrease of 5.9% from $21.5 million as of March 31st, 2012.

Inventory at March 31st, 2013 was $68.3 million compared to $64.1 million on the same date a year ago. Based on our current bookings, we feel comfortable with our inventory levels heading into our key shipping season.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

(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

Yes, thank you. Thanks for taking my questions. I’ve got a few. Let me actually start just in terms of your outlook. I think coming off of the last – the last call, Q4 call, you guys were talking about I think sort of low-double digit revenue growth in the first half along with kind of 100-plus basis point margin expansion and sort of 10% SG&A growth. Given where we are in the first quarter, can you update that or can you talk more specifically to Q2? I’m just wondering if you’ve got any more visibility on the back half at this point in terms of your outlook there?

David Sharp

Mitch, on the sales side, you know, we – we’re hesitant – we’re conservative on the, you know, giving guidance on the Commercial Military business because of the overhang with the budget. But regarding our Work and Hunting business, we see that as pretty low-single digits and then Weston, obviously, we plan on maintaining that kind of 40% momentum.

Mitch Kummetz - Robert W. Baird

Okay.

David Sharp

Our [inaudible] business will be down because we down because we went ahead, as we announced today and licensed the Wal-Mart program, which has been anywhere from, you know, $2 to $7 million in sales and was, in fact, about $3 million last year. I think they’ll do a much better job of servicing that business than we did and sales will be much better and we’ll have, you know, royalty income.

And then, in the back half, we also expect to see the healthcare start shipping and that will be incremental for last year.

Mitch Kummetz - Robert W. Baird

Okay. And then on commercial military, could you remind us of how big of business that is for you guys? I mean, can you give us sort of – quantify in terms of percentage of sales or something like that?

David Sharp

Yeah, last year it was around 20 million.

Mitch Kummetz - Robert W. Baird

Okay. And are you kind of looking for, you know, the Q1 decline to be kind of the run rate for the year at this point or is it just too hard to tell?

David Sharp

On commercial military?

Mitch Kummetz - Robert W. Baird

Yes.

David Sharp

Yeah, we think that right now it’s looking maybe a decline of 15%.

Mitch Kummetz - Robert W. Baird

Okay.

David Sharp

As we get to the back half of the year, it’s when we start to see the decline last year particularly, in the fourth quarter, so …

Mitch Kummetz - Robert W. Baird

Okay, so you start to anniversary that.

David Sharp

[Inaudible] as we get to fourth quarter.

Mitch Kummetz - Robert W. Baird

Got it. And then on the new program with Tractor, I know you benefited from that in the quarter. Can you just remind us, you know, what did you ship in the quarter and how big that program is for the year?

David Sharp

Yeah, we shipped about $2 million in the quarter.

Mitch Kummetz - Robert W. Baird

All right.

David Sharp

And for the year it should be 8 to 10 million.

Mitch Kummetz - Robert W. Baird

Got it. Maybe just a couple of last items. On the margins, Jim, can you give me the gross margin by segment on the quarter?

Jim McDonald

Sure, for the wholesale it was 32.3, retail was 45.9 and the military was 13.9.

Mitch Kummetz - Robert W. Baird

Got it. Okay, and then I know you guys did a great job on gross margins on the quarter. It doesn’t sound like you expect as much opportunity in the second quarter and then the back half . Can you just kind of walk me through the puts and takes on gross margins in the quarter? I know you guys did a good job through your own factories but it sounds like maybe there were some benefits through fewer closeouts or because the channel cleaned up well in the quarter in the colder weather. How should I think about that?

David Sharp

I think most of our increase was really related to the improved efficiency at the factory as we started producing both the private label and then the military contracts. So we think that those on a year-over-year, they’ll continue through second quarter, maybe not quite as much of the magnitude as we had in first quarter, but still pretty substantial. And then – and particularly in our wholesale business. And then as we move the back half of the year, we’ll be more comparable to where we were last year.

Mitch Kummetz - Robert W. Baird

Okay. And then, is it because you don’t – is there something that you – are there some offsets to those efficiencies in the back half then because I would think that those efficiencies would continue throughout the full year, right?

David Sharp

Well, we started really to get those efficiencies late last year [inaudible] for the P&L in the first half of this year.

Mitch Kummetz - Robert W. Baird

Got it, okay. And then last question, David, you referred to the cold weather and kind of clearing up the inventory in retail and I think you said that that’s helping out with your orders as well. Could you just kind of give us a little bit more detail on that? I mean, is there just less carryover inventory at retail now than there was a year ago at this time that’s prompting retailers to want to place a few more pre-book orders than what you were seeing at this time last year?

David Sharp

I think there seems to be a little bit more optimism going into this season versus last year, retail is certainly a cleaner. You know, they went into the last year very conservatively and had a poor experience early in the season but then from December on into January, you know, the weather really cooperated for them to liquidate their inventories and we had a pretty good – we were pretty clean too, hence the lack of closeout sales in the quarter.

Mitch Kummetz - Robert W. Baird

Got it, okay.

David Sharp

So I think there seems to be more optimism, the Stillwater, of course, that’s – trying to understand this category, you know, the weather patterns are definitely changed.

Mitch Kummetz - Robert W. Baird

Got, all right. Thanks, guys. Good luck.

David Sharp

Thank you.

Operator

(Operator Instructions). Our next question comes from the line of John Sullivan from Olsten Capital. Please proceed with your question.

John Sullivan – Olsten Capital

Hi, thanks for taking my question. I was just wondering if you could give a little bit more detail on the accounts receivable balance increases in the quarter? I know usually coming out of your third and fourth quarters, you know, you’re collecting going into fourth quarter and coming into Q1 and it seems like the year-over-year increase is a little bit of a disconnect with sales and whether that has to do with more relaxed terms with tractor supply or just timing-related stuff would be helpful. Thanks.

Jim McDonald

Yeah, I think – this is Jim. The increase is really related to – we really began shipping the tractor supply in march and we actually have shorter terms on those but we shipped that out significantly in March, mostly all the 2 million that shipped came in March as well as the military business, all of the 900,000 we shipped in March. I think it’s just the timing of when our shipments went out and our shipments were larger in March than they were last year in March, so that’s really the only reason for the increase in receivables.

John Sullivan – Olsten Capital

Thank you very much.

Operator

(Operator Instructions). There are no further questions in the queue. I’d like to hand the call back over to management for closing comments.

David Sharp

Thank you very much for joining us today and we look forward to speaking to you again in 90 days. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect now.

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