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Rocky Brands Inc. (NASDAQ:RCKY)

Q1 2010 Earnings Call

April 22, 2010; 04:30pm ET

Executives

Mike Brooks - Chairman & Chief Executive Officer

David Sharp - President & Chief Operating Officer

Jim McDonald - Chief Financial Officer & Treasurer

Analysts

Kevin Ken - Robert W Baird

Reed Anderson – 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, 2009.

Now I’ll turn the conference over to Mr. Mike Brooks, Chairman and Chief Executive Officer of Rocky Brands.

Mike Brooks

Thank you, and I thank everyone for joining us this afternoon. With me on today’s call are David Sharp, President and Chief Operating Officer; Jim McDonald, our Chief Financial Officer and Treasurer.

Today we reported first quarter results that were a significant improvement over the same period a year ago. This included 12% revenue growth, driven by the sales gains in our wholesale and military segments; a 50% reduction in our loss per share. In our wholesale channels we experienced positive reaction to many of our new work lines, which is translated into healthy reorders for several top selling styles.

Over the past year we put greater emphasis on product design, focusing on developing innovative footwear that is comfortable and durable, while at the same time more visually appealing to the consumer, and this has helped us regain important market share.

We’ve also improved our inventory management, and increased our speed to market, which has been critical over the past 12 to 18 months, as retailers are now buying closer to season. This has helped us dramatically lower our borrowing on our credit facility and has reflected in our funded debt levels being down more than $39 million or 46% to $46.7 million at March 31, 2010, from $86.2 million on the same date a year ago.

Our EGL sales were down mostly, however it was the smallest decline in over a year as we continue to successfully transition more accounts to our direct order, direct ship platform. We began this process in Ernest late in 2008, and we were up against tough sales comparisons through 2009, as we took more of our mobile shoe stores off the road. But while sales were down in 2009, expense also came down and as we began 2010 we are well positioned to drive operating leverage in this division.

Finally sales of the footwear to the military increased nearly $5 million compared to a year ago, and shipments under our $29 million contract had accelerated. To-date we received $8 million of the $14.25 million we have received in purchase orders under this contract, but remaining 6.5 million should be shipped during the second and third quarter. We are currently awaiting the delivery schedule for the remaining $14.5 million.

I will now turn the call over to Jim, who will review the financials in more detail.

Jim McDonald

Thanks Mike. Net sales for the first quarter increased 12% to $56.1 million compared to $50.1 million for the corresponding period a year ago. Wholesale sales for the first quarter increased 5.2% to $37.9 million, compared to $36 million last year.

The sales increase was driven by a 9.4% gain in our work category, with our own brand, Georgia Boot, and Rocky combined increasing 14%, while our license brand Dickies declined 20.6%. In addition sales in our western category increased 13.7%. We also experienced a modest increase in our hunting category, offset by a modest decrease in duty sales.

Detailed sales for the first quarter were $12.9 million, down 5.7% from sales of $13.7 million a year ago. The modest decline was the result of our ongoing transition to a more direct order, direct-shipped platform, and the decision to our Lehigh mobile stores from operating to help lower cost.

Military segment sales were $5.2 million versus $0.3 million for the same period in 2009. Gross profit in the first quarter was $18.8 million or 33.4% of sales compared to $20.1 million or 40.1% of sales for the same period last year.

The decline in gross margin was primarily attributable to lower wholesale margin, due to increased manufacturing cost per pair in our company owned factory, and an increase in sales to the military, which carry lower gross margins than our retail and wholesale divisions. We currently project gross margin to increase sequentially over the next three quarters, as cost pre pair in our factories decreased as a result of increased production schedules.

Selling, general and administrative expenses decreased 9.6% or $1.9 million to $18.0 million or 32.1% of sales for the first quarter of 2010, compared to $19.9 million or 39.8% of sales a year ago. The decrease is primarily the result of reductions in salaries and benefits, bad debt expense and Lehigh mobile store expenses.

Income from operations increased to $732,000 or 1.3% of sales for the period, compared to income from operations of a $146,000 or 0.3% of sales in the prior year. Interest expense for the first quarter decreased 7.3% to $1.6 million, from $1.8 million for first quarter of 2009, as a result of reduction in average borrowings compared to the same period last year. Our net loss improved 50% to $560.000 or $0.10 per diluted share, compared to a net loss of $1.1 million or $0.20 per diluted share in the first quarter of 2009.

Now turning to the balance sheet. Funded debt as of March 31, 2010 decreased 45.8% or $39.5 million to $46.7 million, compared to $86.2 million as of March 31, 2009. Our accounts receivable decreased 15.8% to $40 million versus $47.5 million. This is particularly important as the decrease came during a period when sales increased 12%, highlighting the improvement we have made managing our receivables. Inventory decreased $25.3 million or 32.2% to $53.1 million at the end of the first quarter, compared to $78.4 million of the same day a year ago.

Now David will update you on the growth initiatives we are working on for this year.

David Sharp

Thanks Jim. As we discussed on our last earnings call, we have four distinct initiatives that are centered on growth. The first involves the brand and line expansion of our Georgia, Durango and Rocky 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 in line extension. In both Q4 of last year and Q1 of this year, we have begun to see the fruits of aggressive line extensions in our work segment with our Rocky and Georgia brands. Those brands in the quarter experience sales increases in the mid-teens, and by restructuring the way we bring new products to market, we have build a solid backlog of orders for new products scheduled to ship, beginning in the third quarter.

We have four product releases a year versus one annual sales push. Just briefly we should touch on the pent up demand for our basic work group products and the effect on our reorder business. In the fourth quarter of last year, we saw blue collar consumers begin to return to our dealers locations to purchase work boots. This trend improved in Q1.

Probably the most shining example of this, is that one of the largest accounts and national farmed ranch chain where we have a matured Georgia boot business, and where in March our retail results were up 23%, and comp store sales of Georgia products were up 16%.

So with respect to the outlook to sales in our work boot category, given the selling of new products and the strength of our sell through of existing products, we have a great of confidence in replacing the Dickie sales in 2011, which as Jim mentioned declined year-over-year by 20% in Q1. Also it is important to know that the gross margin on our own brands are approximately twice those we traditionally realized with the Dickie brand.

Generally we recently watched into new markets with our Western Durango brand, by creating the widest suede boots in the market. Employing an athletic shoe like construction, this collection for men and women appeals to traditional western consumers who we already sell to today and the will open new doors to distribution in suburban and urban markets, with special styling that appeals to the fashion sensibility of this consumer.

These products were delivered in March and our key retails are reporting strong initial sell through and our reordering. For example in the major mid-west and western, these products are selling through 10% per week for the last three weeks.

Last weekend, we introduced new products to our working sales force that we will deliver for holiday. This is the first time we have introduced western products for this holiday season. This collection has already been previewed by our largest accounts and will received. We believe that this line presents a significant opportunity to increase November, December sales in this segment.

As discussed, an important factor of this line extension strategy with Durango and Georgia boot, is that we are able to leverage the new product offering at our existing customers, while giving us opportunity to penetrate new channels of distribution. For example, we are pleased to report that we had been successful with this strategy, as Shoe Carnival, Shoe Show, Underground Station and Journey's.

Our second initiative is to capitalize on the growing popularity of our military boots. With the U.S. military strategy of rather deployment of special operations unit, in some cases they had found a centralized competitive boot procurement isn’t practical. A large and lucrative business has developed to supply the special requirements of these elite troops. With the Rocky brand’s 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 the grassroots center to understand and align the procurement system in place, and to design the products with specifications to meet these service people's needs. We are beginning to see results. The army and airforce exchange service are recently committed to model inventories at key military basis, which will add incremental sale this year.

Our third initiative of customer segmentation in our wholesale division is being largely enabled by our new B2B capabilities. Today in our Western, Duty and Work footwear segments, 70% of our business is written in the form of advance fill ups. Now and incentivized by reports, dealers are motivated in areas such as selling and to predetermine model stocks on a frequent set time schedule.

In the past, and particularly in late 2008, and in the first three quarters of 2009, dealers regularly waited for discounts to purchase that reorders. Now most of our dealers are reordering when they need a product on a weekly or bi-weekly basis. Our fourth initiative to grow our business internationally was one that was gaining velocity early in 2008, and was derailed by the economic downturn.

As we reported on the last call the 2009 regret, we were able to rekindle interest with foreign distributors. We also reported that our Rocky hunting products are sold at 23 European countries by four high profile distributors. We are pleased to announce today that we just signed an additional distributor for Rocky Hunting Boots called ABC Fitted in Norway, Sweden, and Denmark.

With respect to Georgia lifestyle products since our last call, we have signed new agreements with distributors called Asap [ph] in Italy, and Dims [ph] in France, Belgium, and Switzerland. Clearly, the casual lifestyle market in Europe is a great opportunity for us with the American tradition positioning of our Georgia and Durango brands.

Finally, we like to just comment on the progress we are making on our Lehigh retail division, where we continue to have sets migrating the business with a lower cost B2B platform. In the quarter we saw 19.1% of our Lehigh sales come through the web, versus 6.2% a year ago in the first quarter.

Importantly, we are being rated with a high degree of satisfaction from those customers who used to procure from us through legacy global truck service. So we believe that this growth velocity in web sales is the same if total sales will continue.

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

Mike Brooks

Thank you David. After what has been one of the most difficult retail environments that I can remember, during which our primary focus has been on reducing our expense structure, it is very gratifying to begin 2010 with a double-digit sales increase.

Despite the top-line challenges of the past two years, we have remained confident in the strength of our brands and their leadership position in the work, western, and hunting markets; however, we have had to alter our wholesale and retail growth strategies in order to adapt to the changes while on by the recession. Particularly with regards to how consumers are spending their income, and their greater emphasis put on quality and value.

We think we have the right plan in place to expand our business this year, or at the same time keep our cost down. As we get to our key selling season, we would expect better operating expense leverage to translate into improved profitability beginning in the second quarter.

With that operator we are now ready to take calls. Thank you.

Question-and-Answer-Session

Operator

(Operator Instructions) Our first question comes from the line of Kevin Ken with Robert W Baird. Please proceed with your question.

Kevin Ken - Robert W Baird

Hi guys, can you hear me?

Mike Brooks

Yes Kevin.

Kevin Ken - Robert W Baird

Hey congratulations on the quarter, it sounds like things are moving in the right direction now.

Mike Brooks

They sure are.

Kevin Ken - Robert W Baird

So, a couple modeling questions first. In terms of the sales outlook for the balance of the year, I think you said Q2 and Q3 should see some military sales. I think the $6.5 million and then it sounds like there is $14.5 million that could possibly hit some time this year, but can you guys help us model out what you are seeing in terms of the wholesale versus retail in military sales throughout the balance of the year.

Jim McDonald

Kevin, this is Jim. With regards to military, I think we have $6.5 million left to ship of the $14.5 million that we got. We have got purchase orders already. There is another $14.5 million as part of that contract, that we are waiting to see whether that can be shipped anytime over the next four years, and hopeful we’ll have some information on that soon.

I think we will continue at about the rate in the second quarter that we had in the first quarter, and then the balance of the $6.5 million will be shipped in the third, and hopefully some of the other $14.5 million, but we just don’t know at this point.

With regard to wholesale and retail, we still feel good about those, particularly wholesale continuing to have increases in sales as we move through the next three quarters on a year-over-year basis. At retail, a little bit less until we anniversary the higher sales that we had in the first two quarters last year, because we have removed some of the trucks from operations at that point.

Kevin Ken - Robert W Baird

Okay, so retail Q2 and Q3, we are probably not going to see any increases in sales.

Jim McDonald

I think that would be fair, yes.

Kevin Ken - Robert W Baird

Then, gross margin outlook, you guys provided some detail there, but in terms of the SG&A I think it was down to about a little over $1 million this quarter year-over-year. What are you guys expecting for the balance of the year.

Jim McDonald

Well I think we are staring to anniversary some of the reductions we made last year, in the late first quarter, and we are also planning as we told you before in the fourth quarter call that we are planning on reinventing some in advertising, so we may see some modest decreases, but certainly nothing to the level that we saw in the first quarter.

Kevin Kim – Robert W. Baird

So would it be fair to say we’ll see a decline in Q2 and Q3 and may be an increase in Q4?

Mike Brooks

Maybe more flattish in Q2 and then prove more flattish thought the rest of the year.

Kevin Kim – Robert W. Baird

In terms of the inventory, you got it very clean. How does that work out with the 12% increase during the quarter, and what are you guys planning on doing with inventory for the balance of the year?

Mike Brooks

Kevin, I think you will not see the drastic decreases in inventories that you’ve seen over the last 12 months. I think we’ve got our inventory in pretty good position. I frankly would like to see a little more inventory. The inventor is in great shape. There is some pressure from Asia on getting deliveries. Nothing out of control, but the question is, will your inventory continue to decrease? no it will not. With our sales increasing, our inventory actually hasn’t yet started to increase.

Kevin Kim – Robert W. Baird

Okay, that makes sense. In terms of the debt, very good in terms of the payment down, what do you expect over the balance of the year there?

Mike Brooks

I think the year-over-year decreases in inventory are going to last, because we are starting to anniversary it and we are really starting to decrease the inventors last year and then the debt came along with that as we moved into the second and then really into the back half of the year. So on a year-over-year basis those differences will be certainly different than at the end of the first quarter this year.

Kevin Kim – Robert W. Baird

All right. Mike, Jim, David, thanks a lot.

Mike Brooks

Thanks Kevin.

Operator

Thank you. Our next question comes from the line of Reed Anderson with D. A. Davidson & Co. Please proceed with your question.

Reed Anderson – D. A. Davidson & Co

Hi Guys.

Mike Brooks

Good evening Reed.

Reed Anderson – D. A. Davidson & Co

I joined the call a little bit late, so you may have covered some of this, and I apologies if that’s the case, but a couple of things I want to touch on. In terms of gross margin, I saw the comments in the press release, but there is some people in your industry talking about little higher costs in the second half or maybe something that’s coming back. Just curious like what are you seeing, is that the case for you, and if not, when might you anticipate some more costs coming back into the product site?

Mike Brooks

Well, we are aware of what your hearing and the fact is I leave tomorrow for China for our annual trip over. There is certainly indication that there is come inflation going on in the sourcing side from leather to rubber outsoles, to labor, but the good news is we bought through, we go out quite our ways; we are bought though October this year.

There is no doubt in my mind later this year, early next year there will be higher prices I believe across the board for all footwear segments. We are very confident. We are monitoring every day. Its coming, and I just can’t tell you when its coming, but our hope would be that we wouldn’t have to do anything this season.

Reed Anderson – D. A. Davidson & Co

That sounds like your pretty well planed out. Then in terms of pricing what’s been your experience with them. Obviously your order cycle has picked up, so that reflects the things you’ve done and as well as the overall market picking up, but pricing wise what’s kind of been going on there, I’m just curious.

Mike Brooks

The wholesale pricing, there was a lot of pushed back last year. We had to influence purchasing by discounting. That’s released itself a little bit. We have to be price competitive with our competitors, and we’ve got to control cost. We engineer these shoes for price points and we’ve been thought this before. I think we are going to move into a inflation area period, and those are not all bad for the industry or business, so we’ll just have to manage it to the best of our ability.

Reed Anderson – D. A. Davidson & Co

But at this point relative to where we are today we see our goal, at least some stability back in place.

David Sharp

Our average selling price then in all categories is up verses last year. Customers who want to buy good quality, comfortable, well engineered shoes they will search out for quality brands and buy from them.

Reed Anderson – D. A. Davidson & Co

Lastly, just seeing your business going to come back and are you actually hiring people now or are you kind of keeping a lid on it. I’m just curios to kind of what your view on just overall on stuff like that is like.

David Sharp

Corporately we are not hiring. Hiring is in our plant. We still have a number of plants and we make a large, maybe 20% of our sales. So we have been increasing our own manufacturing plants and frankly that’s another debt against inflation coming from China. So we are not looking to hire corporate, but we will increase manufacturing capacity through hiring when needed.

Reed Anderson – D. A. Davidson & Co

Good enough. That’s it from me. Good luck.

Operator

(Operator Instructions) Gentlemen it appears there are no further questions. Do you have any closing comments?

Mike Brooks

No. I think you very much for listening in and we’ll look forward to reporting to you at the end of Q2. Thanks.

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