Rocky Brands' CEO Discusses F3Q 2013 Results - Earnings Call Transcript

Oct.30.13 | About: Rocky Brands, (RCKY)

Rocky Brands Inc. (NASDAQ:RCKY)

F3Q 2013 Earnings Conference Call

October 30, 2013 04:30 PM ET

Executives

Jim McDonald - EVP and CFO

David Sharp - President and CEO

Analysts

Mitch Kummetz - Robert W. Baird

Mark Cooper - Pacific Ridge

Operator

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to the Rocky Brands Third 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 would like to remind everyone that this conference is being recorded.

And I'll now turn the conference over to Jim McDonald, Chief Financial Officer of Rocky Brands. Thank you sir. You may begin.

Jim McDonald

Thanks everyone for joining us. 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 our 10-K for the year ended December 31, 2012.

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

David Sharp

Thanks, Jim. In addition to our third quarter results, we also announced today that we’ve signed a definitive purchase agreement to acquire the Creative Recreation brand trademark with other assets and liabilities which Jim will detail shortly.

I will first discuss our recent performance and then talk about the acquisition. I will talk about the reasons behind our decisions to deploy capital to purchase the Creative Recreation brand and why we believe this acquisition will help positively shape our future performance. We are obviously disappointed with how the third quarter came together. After a very good second quarter, when all of our business segments posted solid gains, sales momentum slowed in several categories.

The good news is that we believe this was due to a combination of temporary factors, including a change in timing on certain deliveries versus a year ago, and not indicative of the health of our brands. First, it’s been another mile drive fall this far, the third consecutive year of less than favorable selling conditions for our outdoor category in the third quarter.

After the second quarter in which most of our outdoor retail partners restocked their inventory positions ahead of the season, after operating with relatively lean levels, sell through volumes didn’t materialize at the levels expected and that’s reflected in a soft reorder business. While work is not nearly as weather dependent than is outdoor, the category is still sensitive to warm temperatures and this third quarter was warmer than expected.

Second, the operating environment proved to be more challenging than we anticipated. With the potential government shutdown looming throughout the quarter, consumers and retailers, especially in our commercial military and workgroup businesses became much more cautious with demand. With this overhang now gone, we expect sales trends to slowly pick up as the fourth quarter progresses.

Finally, new product constructions primarily in our Durango’s City line, we delivered an early Q4 this year compared to Q3 a year ago. This shift was offset by another quarter of strong gain through our Durango Weston business, which was up 27% in the third quarter. Following very good sell through in the first half of the year, retailers plan for momentum to continue into the busier second half selling season.

Based on what many retailers have recently reported, it’s clear that traffic was challenging, as consumers decided to pull back on discretionary purchases of apparel and footwear. Therefore we remain confident about our current product offering and believe our third quarter performance was largely due to the combination of timing and external events beyond our control that appeared to have impact most of the industry.

Year-to-date our teams have worked hard to drive growth in our western, outdoor and commercial military categories through compelling new product introductions and an improved selling platform. And while I still feel good about future prospects of our core footwear business, the reality is we don’t currently operate in high-growth areas, making it difficult to consistently expand our topline and generate the leverage we need to deliver sustainable increases in profitability.

This is the primary reason we set out to explore a potential acquisition. We were looking for a brand that had significant growth potential; but didn’t overlap with our existing brands and provided entree in the much broader casual market, a brand that targeted the different consumer and was available at a reasonable price.

In Creative Recreation we believe we’ve found a business that fits all these criteria. Creative Recreation is not a typical casual brand. It’s unique within the space, differentiated by footwear collections, which up until a few years ago had not been available in the marketplace, a fashion forward upscale sneaker fusing style and versatility.

The brand easily transitions from the college campus to the club, from the beach to the boardroom, and from the street to the red-carpet. It’s consumer is much younger, much more of a city dweller, than any consumer Rocky currently targets with our existing brands, save Durango, which has made a push in this direction past few years with its lifestyle collection. I expect there to be some selling and distribution synergies for these two brands going forward.

Creative Recreations’ diversified assortment of products and high perceived value has enabled them to target a wide range of distribution and retail partners through our various prices points and channels. They currently sell in several leading accounts where we currently don’t do business including Barneys, Nordstrom, Dallas, Bloomingdales, Journeys, the Buckle and Tilly’s to name a few.

The brand has also enjoyed popularity in Asia and Europe. We feel Creative Recreation, led by co-founder Robert Nand has made tremendous progress carving out a brand new niche in casual footwear in a relatively short period of time with limited resources. With our well-developed sourcing, manufacturing or logistic capabilities and access to capital, we believe we are the right partner to help Robert and his team unlock the brand’s potential, strategically expand their lifestyle footwear sales both domestically and overseas. At the same we will look to leverage their design expertise across our existing brands and products lines to drive growth and improve the consistency of our annual performance.

I’ll now turn the call over to Jim.

Jim McDonald

Thanks David. Net sales for the third quarter decreased 3.3% to $70.2 million compared to $72.5 million for the corresponding period a year ago. Wholesale segment sales for the third quarter were $57.4 million, compared to $62.9 million last year, a decrease of 8.8%. By category, Weston increased 13% and Work 5%, offset by 27% decrease in Outdoor, 21% decrease in Commercial Military and 33% decline in Lifestyle due to the time new product deliveries David mentioned.

Retail sales were $9.6 million in both the third quarter of 2013 and 2012. Military segment sales increased to $3.2 million, compared to non-Military sales for the same period in 2012. Gross profit in the third quarter was $22.7 million or 32.4% of sales, compared to $26.2 million or 36.1% of sales for the same period last year. The 370 basis point decrease was primarily driven by increased Military segment sales which carry lower gross margins than our wholesale and retail segment and lower wholesale gross margin than year ago, resulting from lower margin private label sale.

Selling, general and administrative expenses were $18.3 million or 26.1% of net sales for the third quarter of 2013, compared to $18.2 million or 25.2% net sales a year ago. The 90 basis point increase in SG&A expense as a percentage of net sales was driven by lower sales and approximately $100,000 in expenses related to the acquisition Creative Recreation trademark.

Income from operations was $4.4 million or 6.3% of net sales, compared to $7.9 million or 10.9% of net sales in the prior year period. We reported net income of $2.9 million or $0.39 per diluted share, versus net income of $5.4 million or $0.72 per diluted share a year ago.

Turning to the balance sheet, our funded debt as of September 30, 2013 was $42.4 million, an increase of 1.2% or $41.9 million as of September 30, 2012. Inventory at September 30, 2013 was $78.9 million, compared to $73 million on the same day a year ago. The increase in inventory year-over-year was attributable to lower than expected sales. Heading into holiday season we feel comfortable with the size and quality of our inventory.

Now I’d like to share few financial details about the acquisition. The purchase price for certain assets including the Creative Recreation trademark will be approximately $11 million, separate to our working capital adjustment at the time of closing was expected to be in the fourth quarter of 2013.

We are funding the acquisition for cash available under our existing revolving credit facility. As I said earlier we incurred approximately $100,000 in expenses related to the acquisition during third quarter and expect to record approximately $1 million in related expenses during the fourth quarter. In terms of the acquisition impact on our P&L, we do expect it to be modestly accretive to earnings in 2014 with net sales of approximately $20 million.

I’ll turn it back to David for some closing comments.

David Sharp

Thanks Jim. We feel good about what we’ve accomplished year-to-date. While our enthusiasm around our core business is being somewhat tempered in the near term due to a more challenging selling environment, it is being offset by excitement for pending acquisition of Creative Recreation. The combination of recent innovative product initiatives and the addition of a young exciting casual footwear brand through our existing portfolio of leading Work, Weston and Outdoor brands has created a solid backbone for future growth. We believe we have sound strategies in place to capitalize on the many prospects that lay ahead to deliver increased value for our shareholders.

Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from Mitch Kummetz with Robert W. Baird. Please proceed with your question.

Mitch Kummetz - Robert W. Baird

I’ve got several questions I want to start just on the quarter itself. I know going into what you guys had said, that your fall order book looked pretty good, I think that the orders there were up year-on-year and then you’d said that you’re being pretty cautious with your reorder outlook. So I’m trying to better understand, I get that the weather wasn’t cooperative and there were some shifts in the business and all of that and the government shutdown, but I guess I’m just still a little bit of at a loss for why the numbers came in so much worse than what was expected, given that whether cancellations on the order book and even though you were being cautious on the reorders, the reorders just come in that much worse when you’re anticipating?

David Sharp

Yes, I think Mitch, you have to remember that 70% of our businesses are advance [ph]. And so we have real visibility into what that’s going to be in the future and it is really -- it can be really damaged by unfavorable weather. And we did suffer a few cancellations but it was really the reorder business that didn’t transpire as we thought it would.

Mitch Kummetz - Robert W. Baird

Okay, and then on the inventory. You mentioned it’s up due to the lower than expected sales but then you’re comfortable with the size and the quality of it. I’m just hoping you could reconcile that a little bit more for me? I would assume it’s higher than you would anticipate, because of the lower than expected sales. I guess I’m just wondering why doesn’t that create a potential problem as you go forward, if you have maybe more inventory than what you would have hoped. I would guess that might create a situation where do you have to close out some product that you weren’t anticipating? Is that not only the case?

David Sharp

Almost the entire increase or more than the entire increases really in our Weston business, where we still have a lot of velocity, we’re up 27% in the quarter and we’re very optimistic about what can happen in the fourth quarter with our Weston business. And all of the categories is the good quality and it’s in line with where we want it to be.

Jim McDonald

And I don’t think these are styles Mitch that are not going forward. It’s just the way we can bring those inventories down is to cut off the supply a little bit here. So we'll make that happen in fourth quarter but it should happen as we move to the first quarter of next year.

Mitch Kummetz - Robert W. Baird

Okay, that’s helpful. And then I think it was the press release, I know you covered this in your prepared remarks but in the press release you talked about more conservative sales outlook for the fourth quarter. Could you just maybe elaborate on that? What does that mean? Are you looking for sales to be up, down, flat, how much?

Jim McDonald

I think in our wholesale business we’re looking for - a little bit over mid-single digit increases. I think retail, there is some upside potential there, 5% to 10% in retail and then in military. I think military will be based on the orders we have now. It will be just probably around $1 million in the fourth quarter.

Mitch Kummetz - Robert W. Baird

Okay, got it. And then Jim, I don’t really -- I didn’t hear it but gross margin by segment on the quarter, did you cover that?

Jim McDonald

I don’t know that I did but I’ll give it to you. I don’t think I did though. I can give that to you now. Wholesale was 31.2; retail, 45.8; military, 14.1. So overall [indiscernible].

Mitch Kummetz - Robert W. Baird

Got it, and then just quickly on Creative Rec, you mentioned that you expect it to be modestly accretive and I think you said that based on $20 million in revenues for 2014. Could you just give us kind of what the run rate’s been on that business for the last -- how is that business trending this year, maybe what it was up last year, just so we get some sense as to kind of what the pace of business has been for them?

David Sharp

On a trailing 12 they’re running at about $24 million - $25 million. Some of that is sort of inventory liquidation because they were in over inventory situation really for a couple of years through pure operations -- core operational execution really.

Mitch Kummetz - Robert W. Baird

So you’re expecting the sales to be down in 2014 versus 2013 as you kind of clean that up. Is that how I should think about that or?

Jim McDonald

No, we think the inventory issue will by, the time of the acquisition transpires they'll be clean. So we're conservative planning sales at $20 million. I think when we looked at the $25 million run rate on it, there were several million dollars of those that were sell outs of discontinued products. And now the inventory clean. We won't have those sales. So there will be maybe less sales but there wasn't much profit in those verticals.

Mitch Kummetz - Robert W. Baird

And Jim, how should I think about the profitability of this business, from a gross or operating margin standpoint?

Jim McDonald

I think it will be little bit better in gross margin than our wholesale business and similar, obviously they have excess G&A until we have leveraged that over a little bit bigger base, but it will be -- it should eventually be, certainly a good operating margin than our current business, probably better because we'll have a bigger base to leverage the fixed SG&A over.

Mitch Kummetz - Robert W. Baird

And then speaking of the SG&A, I mean are there some opportunities for cost synergies here? I imagined as you integrate this or you'll keep the front end located in L.A. and there will be some opportunity to maybe on the backend, move some things over to your end, and eliminate some redundancies there. Is that how I should be thinking about that? Is there a sort of cost synergy number that you guys are looking at for 2014?

Jim McDonald

I think where we're really going to help them is in logistics and sourcing and their organization. No particular departments will leverage what we do here with them. We don't have cost synergy savings number yet.

Operator

(Operator Instructions). Our next question comes from Mark Cooper with Pacific Ridge. Please proceed with your question.

Mark Cooper - Pacific Ridge

Can you give us the cash flow and CapEx number for the quarter?

Jim McDonald

I have the cash flow for the year. It is a use of cash of $11.2 million and the fixed assets are $5.6 million, purchases through three quarters.

Mark Cooper - Pacific Ridge

In your comments about the shortfall, you said it’s some industry trends. Can you be specific about what you would refer to that would give you some confidence that it's not just a Rocky issue here this quarter?

David Sharp

We have visibility in some of our key retailers sales numbers and that is where some of the information is coming from. And we’re also in the retail business. So we're pretty sensitive about what's going on in the marketplace in the U.S. One fifth of what we do here is of retail.

Mark Cooper - Pacific Ridge

Has there been any competitive change from and I know they are not like same lines that you are necessarily but from LaCrosse since it's been under a new ownership for the last year and half or so?

David Sharp

If the question is sort of tilting towards market share, we don't think we have launched any market share, particularly to a brand like LaCrosse. They've had some issues internally with management changes and what not and sales force changes. So although we're not privy to their numbers, I doubt that they’re performing any better than we are.

Mark Cooper - Pacific Ridge

And then lastly, the acquisition that you are about to do, its cash, it’s all paid up front. Are there any types of earn outs or any other ongoing performance type payments that will be related to this?

David Sharp

It's no performance related payments other than the one owner Robert Nand, the President and one of the Co-Founders of this going forward and obviously he has performance base - he has a lot of performance based incentives.

Operator

There are no further questions in queue at this time. I will like to turn the call back over to management for closing comments.

David Sharp

Thank you gentlemen. We look forward to speaking to you again in approximately 90 days with improved results. Thank you.

Operator

This does conclude today's teleconference. You may disconnect your lines at this time and thank your participation.

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