Rocky Brands Q4 2009 Earnings Call Transcript

Feb.18.10 | About: Rocky Brands, (RCKY)

Rocky Brands, Inc. (NASDAQ:RCKY)

Q4 2009 Earnings Call

February 18, 2010 5:00 pm ET

Executives

Brendon Frey - Investor Relations

Mike Brooks - Chairman of the Board, Chief Executive Officer

David Sharp - President, Chief Operating Officer

James E. McDonald - Chief Financial Officer, Executive Vice President

Analysts

Mitch Kummetz - Robert W. Baird & Co.

Dan Meyers - D.A. Davidson & Co.

Operator

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 and thanks to everyone for joining us this afternoon. With me on today's call is David Sharp, President and Chief Operating Officer and Jim McDonald, Chief Financial Officer and Treasurer. We are very pleased with the solid fourth quarter results we reported today after the close. Our operating performance exceeded both internal and external expectations and when we combine the third quarter made for a very rewarding second half of 2009.

Our non-GAAP diluted earnings per share for the fourth quarter improved to $0.24 from $0.13 despite a modest decline in sales as we continue to benefit from a leaner infrastructure and lower interest expense. SG&A expenses were down approximately 15% versus a year ago period, the sixth consecutive quarter of double digit percentage declines. During the fourth quarter we took additional steps to right size our operating platform by further reducing the number of many warehouses used to serve our fleet of mobile shoe centers and relocating the company's customer service center from Nashville to Nelsonville.

As 2009 began, it was clear that the near term selling environment was going to remain challenging. While we did see some pockets of improvement during the year, retail generally continued to be very cautious with their inventory commitments and bought much closer to season. Given the uncertainty about the top line prospects, our focus in 2009 was on further reducing our expense structure, a process we began in the second half of 2007. Improving our accounts receivable and inventory management and investing in R&D to develop innovative new product lines and brand extensions.

We were confident that if we could successfully execute this strategy we would be able to strengthen the balance sheet in a down year and better position the company for profitable growth when the markets recover. We are very pleased with what we were able to accomplish in 2009, particularly with regards to our balance sheet where we ended the year ahead of planned.

As I stated earlier, selling and general administration have declined more than 10% on the year over year basis for the past six quarters. For the full year, SG&A was down approximately 14% or more than $12 million compared to 2008, with the majority of the cost cuts coming out of our retail operations. Since we accelerated the roll out of our direct ship program, we have been able to reduce retail personnel, reduce the number of mini warehouses to 19 from 49 and removed nearly 30 mobile shoe stores from our operations. Elsewhere in the organization we have lowered headcount, produced out customer service better, and instituted a tighter fiscal control across the board.

A direct result of these action became apparent over the last six months of the year where excluding the impact from restructuring charges and tax benefits, diluted EPS improved 60% to $0.74 compared to $0.46 we reported the last 6 months of 2008 despite a sales decline of 7% over that same period.

Equally important was the improvement we displayed in managing our receivables and inventory in 2009. Through a heightened focus on collections we were able to reduce accounts receivable by $14 million or 24% at year end. At the same time we did a much better job of aligning inventory levels with projected sales volumes. They were down 21% compared to a year ago, slightly ahead of sales which were down 15% for the year. These improvements combined to free up considerable amounts of cash and allow us to significantly reduce the levels of borrowing on our credit facility during the course of the year. We ended the year with a total debt of $55.6 million, down 37% or $32.1 million, which in turn lowered our full year interest expense 20% or $1.8 million.

Finally we have spent a good deal of time this past year developing what we believe are exciting and innovative new styles on both our existing collections as well as our new brand extensions. The feedback from retailers has been positive with initial order commitments, giving us encouragement we can grow our top line in 2010. David will now provide more color on each of these operating segments, and then Jim will review the financials. David?

David Sharp

Thanks Mike. Again as Mike noted, as we have been working on reducing inventories, receivables SG&A and debt, we've also been developing top line growth initiatives in our wholesale business that should bear fruit in the near or longer term. But before I discuss these we would like to give you some highlights from the quarter.

Obviously the early and sustained cold wet winter has been helpful in stimulating sales for our hunting, waterproof and insulated Rocky brand of products. Favorable weather coupled with an increase in hunting licenses issued, the first increase in many years offset the earlier declines in the business that we experienced during the first three quarters of 2009. During fourth quarter, sales in our hunting category increased 9% to $6.7 million from sales of $6.1 million last year. We experienced solid sell through at retail with our innovative hunting apparel and thermal underwear systems also. Sales of apparel in the fourth quarter were $4.2 million compared with $4.8 million in the year before.

Our sporting goods retail partners have enjoyed sizable sales increases in the hunting category this year. One great benefit of this is that they sold out of their inventories which were light due to the poor economic conditions. And they are responding well to our new innovative style introductions for Fall 2010 delivery.

Historically in our hunting category we usually experience strong orders in the year following a cold and wet winter.

Now for our Western category, where we sell our Durango and Rocky Western products. In the fourth quarter sales were $7.6 million versus $8.3 million last year. As you're aware there is a fashion trend in western boots, particularly women's western boots. However the demand outpaced our suppliers key styles and we were unable to fully capitalize on the sales during the holiday season.

Now turning to the sales of our Duty category. Sales in the quarter increased slightly to reach $5.1 million compared to $5 million last year. More important growth strategies in this category in a minute.

Finally in our Work boot category, our largest volume category. Sales for the quarter were $21.3 million versus $23.5 million in 2008. By far our strongest quarter in 2009 on a comparative basis. We were pleased to see that the consumer was back shopping and our retailers were filling in their depleted inventories with more confidence versus earlier in the year.

So this ends commentary on our wholesale divisions fourth quarter sales performance. Now to just touch on growth plans at wholesale for 2010.

There were four distinct initiatives. The first involves the brand and line extension of our Georgia and Durango brands. The second involves capitalizing on the growing popularity of our military boots. The third involves customer segmentation and the fourth involves leveraging our brand equity worldwide.

So first, brand and line extension. What we are attempting here is to leverage the brand equity of Georgia boots and Durango in such a way that it is appealing to our existing consumer and dealer network and also will attract new consumers and customers. For example with the Georgia brand, we recently launched (inaudible) by Georgia, which capitalizes on the emerging vintage American trend. The Georgia boots tradition and reputation for classic farm and ranch work products we believe that new consumers will appreciate the brand heritage and authenticity while selecting additions to their lifestyle wardrobe.

Similarly, we recently launched into new markets with our Western Durango brand by creating the lightest weight boots in the marketplace. Employing an athletic shoe like construction this collection for men and women appeals to traditional western consumers who we already sell to today and will open new doors to distribution in suburban and urban markets with special styling to appeal to the fashion sensibility of this consumer. Again thankful to this brand and line extension strategy is that we are able to offer the new product offerings to our existing customers, while attempting to penetrate new channels of distribution.

Our second strategy is to capitalize on the growing popularity of our military boots. With the US military strategy of rapid deployment of special operations units, in some cases they have found that centralized competitive boot procurement is impractical. A large and lucrative business has developed to supply the special requirements of these elite troops.

It's a Rocky brand tradition of rugged technical product innovation. We are uniquely qualified to understand the needs of these specialized troops. Over the last 18 months we've invested heavily in a grassroots effort to understand and align the procurement system in place and to design the products with specifications to meet these service people's needs. We believe that this effort will bear fruit for us in 2010 and beyond.

Sales in our Military segments in the fourth quarter of 2009 were $3.3 million, compared to $1.1 million in the fourth quarter of 2008. this increase was driven by a GSA contract which we received last year.

Our third strategy is customer segmentation. Our wholesale division is being largely enabled by new business to business capabilities. Today in our Western, Duty and Work footwear segments, 70% of that business is written in the form of (inaudible). Now instead of (inaudible)by rewards, dealers are motivated from behaviors – rewarded for behaviors such as selling into predetermined model stocks on a frequent set time schedule. When these dealers visit the site, we're able to customize offers to them depending on their account status. We're also having our smallest high service slow paying customers transact business with us using the B to B site exclusively and prepaying for shipments with a credit card.

Our fourth strategy, to grow our business internationally was one that was gaining velocity early in 2008 but was derailed by the economic downturn. As 2009 progressed we were able to rekindle interest with foreign distributors. Specifically our Rocky hunting products are now sold at 23 European countries by four high profile distributors. Over the next thirty days, we expect to finalize two additional distribution agreements for our Giant by Georgia boots and Durango branch, one agreement in the United Kingdom and one in France Belgium and Switzerland.

Clearly these capitalizes on marketing in Europe is a great opportunity for us with the American tradition positioning of our Georgia and Durango brands.

Finally, let me just touch on our retail business. As Mike said, we have worked hard to restructure this business for the past 18 months. We can now run this business profitably on lower sales. Our customers are responding to our new business proposition, that as we up the lowest cost work for west solution delivered directly from our central warehouse. Where we can do it properly, we still offer service through our mobile store service. Sales in our retail division were $12.4 million in the fourth quarter versus $15.4 million in the prior year quarter.

I'll now turn the call over to Jim to review the financial results.

James E. McDonald

Thanks, David. Net sales for the fourth quarter decreased 6.5% to $61.7 million compared to $66 million for the corresponding period a year ago. We reported fourth quarter net income of $0.9 million or $0.16 per diluted share versus a net loss of $2.2 million or $0.41 per diluted share for the fourth quarter of 2008.

Results for the fourth quarter of 2009 included restructuring charges of $0.08 per diluted share associated with the closing of 15 mini warehouses that we operated under our Lehigh retail division and the relocation of our customer service to Nelsonville from Nashville.

Results for the fourth quarter of 2008 included non-cash charges of $0.54 per diluted share for the write-down of the Lehigh and Gauge (ph) trademarks. Excluding these charges, net income was $1.6 million or $0.24 per diluted share in the fourth quarter of 2009 compared to net income of $0.7 million or $0.13 per diluted share in the fourth quarter of 2008.

Gross profit in the fourth quarter was $22 million or 35.7% of sales compared to $24.8 million or 37.6% of sales for the same period last year. The decline in gross margin was primarily attributable to the increase in sales in our military segment which carry lower gross margins than our retail and wholesale division.

Selling, general, and administrative expenses decreased 14.7% or $3.2 million to $18.4 million or 29.9% of sales for the fourth quarter of 2009 compared to $21.6 million or 32.7% of sales a year ago. The decrease is primarily the result of reductions in salaries and benefits, advertising expense, Lehigh mobile storage expenses, and bad debt expense.

Income from operation, excluding the restructuring charges, increased to $3.6 million or 5.8% of sales for the period compared to income from operations including the non-cash intangible impairment charges of $3.2 million or 4.9% of sales in the prior year.

Interest expense for the fourth quarter decreased 17.3% to $1.8 million from $2.2 million in the fourth quarter of 2008 as a result of reductions in average borrowing compared to same period last year.

Now for the full year. We reported net income of $1.2 million or $0.21 per diluted share versus net income of $1.2 million or $0.21 per diluted share in 2008. Excluding the aforementioned charges, we reported earnings of $0.29 per diluted share compared to $0.75 per diluted share in the prior year.

Now turning to the balance sheet, inventory decreased $14.9 million or 21.2% to $55.4 million at December 31st 2009 compared with $70.3 million on the same date a year ago. Our accounts receivable decreased 23.8% to $45.8 million versus $60.1 million and our days sales outstanding improved 14% or 11 days on the three months ended December 31st 2009 compared to the same period last year.

Funded debt as of December 31st 2009 decreased 36.6% or $32.1 million to $55.6 million compared to $87.7 million as of December 31st 2008.

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

Mike Brooks

Thanks, Jim. While economic conditions have certainly improved versus this time a year ago, it appears that the recovery is going to be longer and slower than originally anticipated. That said, we are more than optimistic about our growth prospects entering 2010 than we were a year ago, for a few reasons.

First, comparisons in our retail division get easier beginning in the first quarter. Second, our new products and brand extensions will drive increased shelf space at retail and opening new channels of distribution. And third, we will have a full year of military sales from the GSA purchase agreement we received in July. We are confident that our recent efforts to take cost out of the business and enhance the efficiency of our organization, combined with our improved growth prospects, will result in better bottom-line trends in 2010.

Due to the timing of certain expenses, we expect modest year-over-year improvements in the first quarter with more meaningful gains being made in the second quarter. As we get closer to the peak selling season and gain more visibility we will update you on our outlook for the back half of this year.

Finally, I would like to thank all employees for their many contributions this past year, and our shareholders thank you for your continuous interest and support. Operator, we are now ready to open the call for questions.

Question-and-Answer Session

Operator

(Operator's Instructions) Thank you, our first question comes from the line of Mitch Kummetz of Robert W. Baird & Co.

Mitch Kummetz - Robert W. Baird & Co.

Yeah. Thank you. I got a few questions. First, Mike, could you tell us where you are on your transition on the retail business (inaudible) the ecommerce platform? I think on the last conference call it was mentioned that I think it was like 13%-14% of your sales were done on the web in your retail business and I'm wondering if that's an increase in the fourth quarter.

Mike Brooks

Yeah, it did increase in the fourth quarter, Mitch, and we're looking for upwards of 25% over the web in 2010.

Mitch Kummetz - Robert W. Baird & Co.

Okay, upwards of 25%. Could you tell us where it was in the fourth quarter?

Mike Brooks

No, not exactly. I can get back to you, Mitch, on that one.

Mitch Kummetz - Robert W. Baird & Co.

I'm guessing somewhere below 25% then?

Mike Brooks

Oh yes.

Mitch Kummetz - Robert W. Baird & Co.

Okay. So as you move towards that target, a couple of things; I mean, I assume you would be able to continue to take out additional expense as you have over the last year as you've been transitioning that business. So I guess that's the first question. And secondly, it seems as if your transition has hurt you a little bit on the sales side, so as you continue to move that towards that target of 25% should we expect to see continued pressure on the sales piece until we get there?

David Sharp

Actually, I think of sales as an inflection point. We're getting new customers that were being serviced by our competitors and are attracting them with the lower cost solution.

James E. McDonald

This is Jim. I think that we, as David said, we've kind of plateaued out here as far as the sales decrease. There may be some modest decreases, but certainly not to the magnitude that we had in 2009. And as far as the cost structure, we've aligned that now that it's pretty visible to us when a mobile store is not profitable and we can make the appropriate action to make sure that it doesn't become a drag on our profitability.

Mike Brooks

Mitch, it was an old business model that the competition has become very fierce and extremely difficult to make any profit on average and so we had to make these changes. They were the right changes to make, and as we grow the business through the Internet or through our direct shipping of our warehouse in a single location, number one we're passing on a major savings to the manufacturer who is paying for the footwear and we're able to maintain margin. So tough decision, right decision, and I think as David said, we have passed a point that we believe we're going to return very nicely to profitability.

The sales increases are going to be difficult to come by, but they're going to come because we're offering such a great deal. They can buy shoes much cheaper over our direct shipping then they can through a truck.

Mitch Kummetz - Robert W. Baird & Co.

Okay. And on the military business and this GSA piece which is 3.3 million military in the fourth quarter, I think on the last conference call you were expecting Q4 to be bigger than Q3, and I think, Mike, you're talking about even ramping beyond that in the first half of 2010? I mean, is that the case and what kind of run rate should we be expecting from this in this year?

Mike Brooks

Well, we have this GSA order that was basically half — a little over 200,000 pair which is a little bit over about $16 million that we're aggressively manufacturing as we speak. I'll have to get back to you on the differentials not coming to mind between the first two quarters of last year and this year. I can get you those numbers or Jim can. It will be a sizable increase and we're still waiting to hear on the large DOD business.

We bid on a $100 million Department of Defense business over a five-year period that has been, goodness, it's been out there for about 18 months. We had the last bid opportunity about 6-8 weeks ago right before we saw you out at ICR. So we still haven't heard on that one, and then as David was mentioning, we're picking up more and more high-margin business with our Specialty Forces product which is still going to military, but it's a more full margin business.

Mitch Kummetz - Robert W. Baird & Co.

Okay. And then let me ask one last question, on the SG&A you guys have done a nice job managing that down $3 million plus in the quarter and down $12 million plus for the year. How should we be thinking about that in 2010? I'm guessing you'll see some additional cost savings as a result of closing this many warehouses, but I'm also wondering how we should be thinking about certain line items in the SG&A-like salaries and benefits and advertising expense which you guys called out in the press releases as being down. Do those come down even further or are you starting to think about reinvesting in certain areas as we go to 2010?

James E. McDonald

Yeah. We do have some cost savings coming from the closing of these many warehouses and in the release we put out we estimated them at approximately $2 million. We are planning though. We have been cutting back on advertising expenses over the last, particularly last year and even going back into '08. So we are planning on reinvesting back in some advertising of the brands and so those two, for the most part, are a wash there. I think SG&A going forward will be — we've kind of hit steady state on that and maybe have some savings there and the only increase in SG&A would be for our variable SG&A as we move forward which is our commissions and our distribution expenses.

Mitch Kummetz - Robert W. Baird & Co.

Got it. Okay that's helpful. Thanks, good luck.

Operator

(Operator's Instructions) Our next question comes from the line of Dan Meyers with D.A. Davidson & Co.

Dan Meyers - D.A. Davidson & Co.

Hi, guys. I'm just wondering if you had any more details on the increased shelf space and new channels of distribution at retail, kind of where you see this happening? Thanks.

David Sharp

For example, with the new line extensions we've done and the lightweight products that we've done and the western Durango brand we've had a lot of interest from Genesco at Underground Station and Journey's for fall of 2010. We currently have the product at Shoe Carnival and this receives reorders and commitments to more stores for fall of 2010.

We're seeing quite a bit of interest in our kids line in western and we've had interest from retailers like Nordstrom and retailers like David Z. in New York has indicated interest in the new line extensions in Durango. So these are all — our business is substantially today in the core western market and these are all outside of the core western market.

Dan Meyers - D.A. Davidson & Co.

Okay, thanks. Any details on kind of the outdoor category that you've seen? Any impacts from retailers going out of business or any pickups in certain areas of that channel?

Mike Brooks

Dan, this is Mike. Last year, not '09 but '08, was the worst year I have ever seen in large retailers in the outdoor business going out of business and bankrupt, but that did not reoccur in '09 which was good news. But there are not a lot of new players in the outdoor market, but really what we're seeing there is that the appetite is much greater in verbals and in hard orders and the pipeline is pretty thin. So it is the majors. It's the Vispros (ph) and the Gander Mountains and the Cabela's in a smaller way, but it's the majors that are — Dick's Sporting Goods, that are committing to a higher percentage than we have seen in some time and so we're encouraged with that, obviously.

Dan Meyers - D.A. Davidson & Co.

Okay great, thanks. That's it.

Operator

Our next question is a followup question from Mitch Kummetz of Robert W. Baird & Co.

Mitch Kummetz - Robert W. Baird & Co.

Yeah, thanks. Actually I've got a few more for you guys if you don't mind. Jim, on the down $32 million plus for the year, funded by working capital management as the inventories come down, I think it was down what, 21% at year end? How are you guys thinking about inventory in 2010? I mean, is that down to a level where you're kind of flattish going forward kind of on a year-over-year basis or is that still kind of a source of cash for you guys to continue to pay down debt as we work through the year?

James E. McDonald

I think it's still a source of cash for us as we move forward, but not to the extent that we had in 2009 so there will be some sources of cash there, but not to that extent.

Mitch Kummetz - Robert W. Baird & Co.

Okay, thank you. And then on the gross margin, the gross margin was down in the quarter year over year and Jim, you mentioned that a lot of that came from the military. If I did my math right, if I strip out the military it still looks like your gross margin was down a tad. Could you maybe address that or give us what kind of the gross margin was by the retail and whole segments and then how are you thinking about gross margin in 2010? I mean, obviously probably still some pressure from mix, particularly in the first half from military, and I don't know if you're seeing some pressure from product cost coming into the back half of the year as we've heard that from some other companies.

James E. McDonald

Yeah. Our gross margin on our wholesale business was 34.8% in the fourth quarter. That was actually up from 34% in '08. Our retail margin was 45% versus 51% and as we move more to this direct shift we give incentives, as Mike said earlier, to our customers. So our operating margin was up, but our gross margins were down if you took the expense out of it.

Mitch Kummetz - Robert W. Baird & Co.

Got it. And then I would imagine that you have a similar impact from retail, at least through the first half of 2010? Is that right as you're continuing to get incentives, but benefiting on the SG&A side?

James E. McDonald

Yeah. I think as we continue to — as the direct order through the Internet ship business continues to grow you'll see margins come down as it becomes a bigger percentage of our business, but operating margins go up.

Mitch Kummetz - Robert W. Baird & Co.

Okay. And then final question for David, in your remarks you talked about the hunting business and the benefits that you saw there from weather and in a typical year when that happens that that positively impacts your pre-books the following year. I think you guys have been into SHOT Show and some other tradeshows I would imagine. I mean, what are you seeing in terms of fall pre books for the hunting business or at least some preliminary conversations there and is that kind of typical cadence of the past? Would you expect that in 2010 or are we just in a different environment now?

David Sharp

I think we're probably benefiting from the retailers went into the season very, very lean based on the economic conditions and the short season nature of the hunting business. And we're very conservative and they had a very, very good — they had a blowout season, the retail, because of the weather hunting licenses were up also. So actually, SHOT Show was the busiest show that I've attended in probably five years of any show, (inaudible) or the Denver western market. It was an extremely busy show with a lot of confidence expressed from retailers, both big and small.

So I think we're going to see our business improve with most of the majors, if not all of them.

Mike Brooks

I think all the majors.

David Sharp

And we've also become better aligned in the last 12 months with some high-end groups and those shows have been going very well too. So I think that at this point we're pretty optimistic about fall-winter 2010 in our hunting business.

Mike Brooks

I'll just echo David on the SHOT Show. It was so exciting to see interested crowded aisles and interested customers. And the SHOT Show has evolved from the hunting and sporting good side really to military. The world comes to the SHOT Show and buys military. We have a separate booth for our military and duty line and that booth was packed and so it's a dual — if you haven't been in a while, Mitch, and I know you probably don't need another show to go to, but if you could get there for a day you would feel what's going on.

Secondly, or lastly, you mentioned price increases possibly you're hearing. We're hearing that also, but I don't think it's going to affect us greatly this year. I think we'll be able to get through 90% plus of the year without having to pass on a price increase, but it's definitely coming, and probably more concerning than pricing or as concerning as pricing is availability of quality footwear, getting products made on a timely basis.

Mitch Kummetz - Robert W. Baird & Co.

Okay. Let me ask you one other question. On the Durango business it sounds like you're having some success placing these line extensions, and I'm just wondering, it would be more on the core business, it seemed like this past holiday season we had kind of a broader women's boot trend again, and I think that did encompass western boots to some extent. And I know that we went through kind of this period almost three or four years ago where western was trending well, how do you think about that business? And I don't know if there's anything you can in terms of the pre-books there with maybe retailers wanting to increase their orders on just women's fashion boots in general, including western?

David Sharp

I think one good indicator of our business there is — you know, this business is very fragmented in retail. You have a lot of small independent retailers and just a handful of large kind of regional players. And our business with those regional players, we're getting more and more shelf space there. I think that the smaller independents continue to be conservative because of their economic conditions, but I think it's certainly an area that we're very focused on from a product development standpoint and a marketing standpoint and I think that we're in a good position because competition wise there are very few players in the market that have the design sourcing and marketing capabilities that we have. So I think that's playing well for us.

Mitch Kummetz - Robert W. Baird & Co.

Okay. All right, thanks again.

Operator

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

Mike Brooks

Thank you very much for calling in and listening. We look forward to building our business and increasing our profits this year. Thank you, operator.

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