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Rocky Brands Inc. (NASDAQ:RCKY)

Q4 2013 Earnings Conference Call

February 25, 2014 04:30 PM ET

Executives

Jim McDonald - EVP and CFO

David Sharp - President and CEO

Analysts

Mitch Kummetz - Robert Baird

John Sullivan - Olstein Capital

Operator

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to the Rocky Brands Fourth Quarter and Fiscal 2013 Year-End 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 given 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 we'll now turn the conference over to Jim McDonald, Chief Financial Officer of Rocky Brands.

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. And welcome everyone to this afternoon’s call. We finished 2013 on a solid note, highlighted by a 9% increase in wholesale footwear during the fourth quarter. In addition our Retail and Military segment sales were also up over the last year. Work footwear a largest category, had one of its best quarters in sometime, increasing 20% driven by strong sell through of our Georgia and Rocky brands, combined with the contribution from our private-label business that launched with TFC in early 2013.

We definitely benefited from favorable weather as it was cold or wet in many areas of the country throughout the fourth quarter. At the same time we were in a much stronger inventory position versus a year ago, which allowed us to capitalize on pent-up demand for work boots following back-to-back mild winters. We put a great deal of effort into improving our product lines to feature even more comfortable and durable styles with great value propositions.

Consumers have responded very positively to our efforts, which have helped strengthen our retail relationships and leadership position in the work category. For the Rocky brand, this includes the IronClad collection, which sold through very well in Q4 and that momentum has carried over into the first quarter. Meanwhile the early response for the Georgia brand's new Homeland collection of waterproof boots has been very positive. There has long been a need in the workspace for quality products that can retail under $100 to $120 range, while still providing strong margins for our wholesale accounts.

Excitement for the collection let us to pull forward some initial deliveries from Q1 into Q4 and consumer demand has been strong since its debut. Finally on work, we completed the first year of our private-label program with attractive supply, with a solid fourth-quarter. The full-year result of this new venture handedly [ph] exceeded expectations and has cemented our relationship with this important account which should help us grow our branded Georgia Boot business there in 2014.

Our Rocky Hunting category also benefited from the cold weather in Q4. Sell in and sell through were up double-digits in the fourth quarter, leaving us and our retailers in a good position, as we begin planning for the upcoming hunting season. Young cold weather categories, it appeared it was a challenging holiday season for much of the footwear industry. We did feel some pressure on our less leather sensitive categories as the result of weaker than expected store traffic at many of our retail partners.

That said, there were areas of strength outside of work and hunting during the fourth quarter, most notably with our Durango brand which should have been a standout for a solid year. Since evolving the product line and broadening the brand position to go after a younger, more urban consumer, we successfully expanded distribution to more mainstream footwear retailers such as Amazon, Blue Pond and Zappos to name a few. Durango sales were solid during the fourth quarter across new and existing accounts, underscoring the strong response to the improved merchandise offering.

Looking at our commercial military business, our S2V product line continues to enjoy strong support among military personnel with its many versatile features. While we believe the demand is there, sequestration, deployment of drawdowns and the beginning of another year of uncertainty within the government have created the challenging selling environment.

Despite this headwind, we are seeing the S2V Jungle Boots being considered for wide used within the U.S. Army, which along with the developments of a boot for the aviation community has encouraged about the category's prospects this year. Adding to this optimism is broader distribution for our C4T garrison training boot within the Army and Air Force exchange system. This includes a line-of-sight offering and increased number of doors. And later this year, we’ll begin selling the C5C Rocky’s latest cutting-edge military design boots which has pre-booked very well. When analyzing our overall wholesale performance, it’s important to remember that we transitioned to a licensing structure with our thermal underwear program at Wal-Mart early in 2013. This made our top line comparisons more difficult in Q3 and Q4.

Turning to our retail segment, where we recently completed the five-year transformation of our Lehigh distribution model from mobile stores to the web, we ended 2013 with just three shoemobiles, compared to 21 the year before and 103 five years ago. We now interface with our customers through much more cost effective on-site GS locations, of which we currently have about 380. This initiative drove a 40% increase in our custom-fit order program in 2013 and we project this trend to accelerate as we lack [ph] easy comparisons later in the year.

The largest contribution to our retail segment in the fourth quarter and the full year came from our direct-to-consumer eCommerce channel where we've continued to invest time and resources in order to capture additional demand. In early November, we moved to rockyboots.com to a new platform run by Demandware, which has increased the speed of our site, including content delivery and significantly enhanced the overall consumer experience. The impact has had a measurable effect on sales.

In addition to transitioning our Durango Georgia Boots and Creative Recreation eCommerce website for the Demandware platform, we’re now focused on optimizing the customer experience regardless of the device with which they’re using to view our system services. Whether it’d be a PC, tablet, or smartphone we will provide a consistent best in class experience utilizing responsive design technology.

Finally, with regard to Creative Recreation, the acquisition closed on December 13 and we moved quickly to relocate the brands inventory to our 3PL in Washington State by yearend. We’re still integrating the pieces of their organization that moved over in the transaction, while at the same time ramping up the selling process.

We feel good about where we are on both fronts and continue to be very excited about the long-term potential of the deal. Creative Recreation has several compelling attributes that make it a great fit for us. The brand has significant growth opportunities. It doesn’t overlap with our existing brands and it provides entry in the much broader casual market and it targets a different consumer. Since the acquisition in mid-December, we’ve been working hard on on-boarding the company onto [indiscernible] and other systems, which will help the brand compete and serve their customers better.

Further, due to approximately two years of financial stress which Creative Recreation experienced prior to the acquisition, we are already fixing supply chain process issues, specifically late deliveries. The Creative Recreation U.S. sales team just attended the Agenda and Liberty fair shows at Long Beach, Las Vegas and Manhattan and we had people in attendance at Bread & Butter in Europe.

Here in the U.S., we’ve been encouraged by the commitments from the retailers like Urban Outfitters, The Buckle Tote, and Nordstrom to expand their number of doors featuring the brand this fall season. Outside of the U.S., we’re experiencing strong growth with the brand, strongest in the United Kingdom where we anticipate doubling sales this year and our distributor there was also licensed for an apparel test last year and sold $0.5 million for the winter season and the retail customers reported very good sell through.

We expect to drive 50% of Creative Recreation’s sales this year outside of the United States. We already have 20 distribution agreements in place and we had meaningful discussions at the Bread & Butter show with new distribution partners to fill in the missing gaps to complete the European distribution demand. In terms of the future, we believe overtime that Creative Recreation will benefit from our operational capabilities and access to capital to expand the brand's top line in profitable and meaningful way.

I'll now turn the call over to Jim.

Jim McDonald

Thanks, David. Net sales for the fourth quarter were $61.6 million, compared to $58.3 million for the corresponding period a year ago. Wholesale sales for the fourth quarter were $47.7 million, compared to $46.2 million last year. The $1.5 million increase was driven by a $3.8 million or 9% in footwear sales, partially offset by a $2.3 million decrease in apparel sales. As David referenced earlier, the decrease in apparel sales was a result of our decision to transition some apparel to a licensing model in early 2013.

Retail sales for the fourth quarter increased to $12.9 million, compared to $12 million a year ago. Military segment sales increased to $1 million, versus non-military sales for the same period in 2012. Gross profit in the fourth quarter was $21.8 million or 35.4% of sales, compared to $20.9 million or 36% of sales for the same period last year. The 60 basis point decrease was driven by increased military sales versus a year ago period, which carry a lower gross margin. Before I discuss expenses in the bottom line, I’d like to mention that the fourth quarter 2013 included a onetime expense of $1 million and a one-time income gain of $600,000 related to the acquisition of Creative Recreation which closed on December 13, 2013.

Also included in the fourth quarter of 2013 were expenses of a $172,000 associated with the ongoing operations with Creative Recreation. Selling, General and & Administrative expenses, excluding Creative Recreation were $18.4 million or 29.9% of net sales for the fourth quarter of 2013, compared to $16.8 million or 28.8% of net sales a year ago. The 110 basis point increase in SG&A was driven primarily by the reversal of incentive competition accruals in the fourth quarter of 2012.

Income from operations, also excluding the expenses I just mentioned was $3.4 million or 5.6% of net sales, compared to $4.1 million or 7.1% of net sales in the prior year period. Our fourth quarter interest expense was $0.2 million, flat with last year. Our effective tax rate for the fourth quarter of 2013 was 27.4 %, compared to 31.8% in the fourth quarter of 2012. The layer effective tax rate was the result of additional permanent capital investment and our Dominican Republic operations in 2013. GAAP net income was $1.8 million or $0.24 per diluted share. Excluding our expenses and income related to Creative Recreation, net income was $2 million or $0.29 per diluted share, versus net income of $2.5 million or $0.34 per diluted share last year.

I’ll just quickly touch on a few highlights from the full year. Net revenues for 2013 increased 7.1% and included a 5.1% gain from our wholesale footwear business. The strongest performing categories were western and work, which were up 21.2% and 11.4% respectively for the full year. Excluding expenses and one-time gains associated with Creative Recreation acquisition, full year net income was $7.9 million or $1.04 per diluted share.

Turning to the balance sheet, our funded debt at December 31, 2013 increased to $38.4 million, from $23.5 at December 31, 2012, primarily due to the acquisition of Creative Recreation. Inventory at December 31, 2013 was $78.2 million, which included approximately $1 million in Creative Recreation inventory, compared with $67.2 million on the same date a the year ago.

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

David Sharp

Thanks, Jim. 2014 has gotten off to a good start. The prolonged cold and wet weather has helped drive sell through in our work and outdoor retailers during the first quarter, reducing their on hand inventory and freeing up more open to buy dollars that will now be dedicated to new product introductions.

The strength of our evolved product lines in work, western and outdoor has fueled our best pre book period in some years. Our excitement is being a bit tempered by the uncertain retail environment. However we feel confident that the momentum in our core businesses, combined with the addition of Creative Recreation has us well positioned to improve our top and bottom line performance for the year.

As we've previously discussed, we expect Creative Recreation sales to be approximately $20 million this year and to be modestly accretive to earnings, and as previously mentioned we are currently focused on strengthening Creative Recreation’s operating platform, particularly with respect to supplier chain issues and therefore we expect any accretion to be primarily in the back half of the year. In our core business we’re planning our top line to increase in the mid to high single digits throughout the year.

Operator, we are now ready to take questions.

Question-And-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Mitch Kummetz with Robert Baird. Please proceed with your question.

Mitch Kummetz - Robert Baird

Yes, I've got a handful of questions. Let me start David, you made the comment kind of in your closing remarks that this is your best pre-book period in years. Could you just elaborate on that? How far into your fall orders are you and can you give us a sense as to how much those orders are up year-on-year?

David Sharp

We’re seeing in the range of 8% to 10% of those customers where we know there isn’t a difference in timing. We are seeing about 8% to 10%. I am talking fall, winter.

Mitch Kummetz - Robert Baird

Great, okay. And is that concentrated in any particular part of the business, I mean in hunting and work or also in western?

David Sharp

Hunting and work and heavily [ph] insulated product. Our retailers obviously have, as we mentioned experienced great sell through and that’s where we are seeing a lot of upside right now in the order book.

Mitch Kummetz - Robert Baird

Okay. And then I think you said that you would expect the core business to be up mid-to-high single digits for the year. First of all was that, did I hear that correctly and how does that kind of break out by wholesale versus retail versus military in terms of how you are planning the business?

David Sharp

Yes, and work where -- any of this weather related business, there is a pretty large appetite. So we've planned that up closer to the 10%, 11%, 12% range. Where we see, and obviously our western business, the trend there has been good year-on-year for three years. Where we are concerned that we don’t have the visibility is in our commercial military business because of sequestration and government shenanigans in our duty business because of what’s going on with the postal service. And that pretty much speaks to the, to our wholesale business. The retail business, we have -- planning around 5% right now with the visibility that we have. And our military business, we have planned flat to maybe down a little bit but we don’t know what the orders are going to be on the second year of the contract we have right now. So, the best we have right now will be flat or possibly down slightly.

Mitch Kummetz - Robert Baird

Got it. And Jim, how should we be thinking about margins for the year and then I don’t know how much that changes with Creative Rec coming into the fold?

Jim McDonald

I think margins will be, wholesale margins probably with Creative Rec might be down slightly because of, I think on our ongoing Rocky business will be pretty flat with [indiscernible] in the '13 [ph] plus Creative Rec might be down a little bit because of doing so much business distributors, internationally would have lower margins than again have lower SG&A associated with that.

Mitch Kummetz - Robert Baird

And then how about retail margins pretty consistent or do you think that you see much change in that?

Jim McDonald

I think it will be pretty flat there. We now got this transition from the truck to the web model and so this will be the last year where hopefully after this we will start seeing margins go up as we go to more through e-commerce business where we've got a significantly higher margins than our Lehigh business.

Mitch Kummetz - Robert Baird

Got it. And do you happen to have what the gross margins were for those three businesses in the fourth quarter, wholesale, retail and military?

Jim McDonald

I do, 32.8 for wholesale, 45.8 for retail and 16.3 for military.

Mitch Kummetz - Robert Baird

Got it. And then lastly, you talked about $20 million of benefit from Creative Rec in 2014. Just to give that some context, could you tell just on a pro-forma basis where that business came in for 2013?

Jim McDonald

About the same, a little less.

Operator

[Operator Instructions] Our next question comes from the line of John Sullivan with Olstein Capital. Please proceed with your question.

John Sullivan - Olstein Capital

In your prepared remarks, you guys called out pulling forward of some inventory into fourth quarter on one of your hotter new products. Did you guys quantify that at all for us?

David Sharp

That made up about, I think it was about $800,000 of Georgia product.

Operator

[Operator Instructions] Gentlemen, there appear to be no further questions at this time. I would like to turn the floor back over to management for closing comments.

David Sharp

Thank you and thank you for joining us on the call today. We will be here in Nelsonville, Ohio working hard for the next quarter. Thank you.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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