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Rocky Brands Inc (NASDAQ:RCKY)

Q1 2014 Earnings Conference Call

April 23, 2014 04:30 PM ET

Executives

Brendon Frey – Managing Director Retail, Apparel and Footwear, ICR LLC

David N. Sharp – President and Chief Executive Officer

James E. McDonald – Executive Vice President, Chief Financial Officer and Treasurer

Analysts

Mitch J. Kummetz – Robert W. Baird & Co., Inc.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Alexander Renker – Sidoti & Co. LLC

Operator

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to the Rocky Brands First Quarter Fiscal 2014 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 call is being recorded.

And I’ll now turn the conference over to Brendon Frey of ICR.

Brendon Frey

Thanks. And thanks everyone for joining us before we begin, please note that today’s session, 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 changes, 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 our reports filed with the Securities and Exchange Commission, including our 10-K for the year ended December 31, 2013.

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

David N. Sharp

Thanks, Brendon and welcome everyone. On the call with me this afternoon is Jim McDonald, our Chief Financial Officer. The solid momentum we experienced in the fourth quarter of 2013 accelerated as we started the New Year resulting in records first quarter revenue of $65.8 million. By a large margin we outperformed our internal and external projections for the quarter for both our top and bottom lines. Having said that have we not made certain investments in the quarter, our earnings could have easily exceeded last year with the strong increase in topline.

These investments included the seeding program with a few retail partner, the funding of additional advertising for our Georgia Boot, Rocky, and Durango brands and the startup cost Creative Recreation. We are focused on long-term sustainable growth and we are certain with these investments revealed improved profitability in the second half of the year and beyond.

Back to the quarter sales results. Our best performing segment was wholesale footwear which increased 26% over the last year including 17% gain for our Rocky, Durango and Georgia Boot brands. This topline increase was driven by a combination of factors that include improved product offerings, favorable weather conditions in several parts of the country, leaner inventory levels in the channel and to a small degree the aforementioned seeding program with one of our major customers. These drives help facilitate strong double-digit percentage gains in each of our major categories work, western, and hunting.

In addition, our commercial military and duty categories rebounded with similarly strong performances following a challenging 2013 due to government spending headwinds. Cold wet weather was a benefit in the first quarter; however, weather could certainly work against this in the past. We’ve made a concerted effort over the past several years to strengthen our product lines, to enhance confident to our ability all with the competitive value proposition. While we’ll never be fully immune to the effects of country seasonal weather. We believe building these attributes into a broader products offering that appeals to our target consumer is helping improve our sales over the long-term.

Beginning with our largest category work boots, our sales increased 18% during the first quarter following a 20% gain in Q4. Our Q1 performance was particularly notable as we were lacking the initial rollout of our private-label program with attractive supply a year ago. The strong gains were driven primarily by Georgia Boots, as demand for the brands new Homeland series has outpaced expectations. As we mentioned on our last earnings call, we actually pulled forward the initial Homeland shipments into the fourth quarter in response to retailer request. This gives a good sense of the best start we are off to with this exciting new series.

Rocky work was also up during the quarter on the strength of new product introductions and renewed interest in the brands IronClad collection, which sort of revitalization at retail throughout last year. The soil was the same in western boots as demand for new products from Durango and Rocky along with a restructuring of the western sales operation fueled a 19% improvement over last year.

The Durango, the strength continues to come from the brands Rebel collections including a favorable response to a new kid’s package of leather boots. Key forms channel accounts have expanded their Durango offering following continued strong sell through and we expect this trend to continue.

With regard to the Rocky Brands in western, we recently hired a dedicated sales force in order to refocus our efforts on positioning Rocky western as a work western brand. Price of this Rocky and Durango were represented by the same team. The initial results from this decision have been very encouraging, driven in part by the recent introduction of new Square Toe boots that target more of an outdoor work consumer.

Now turning to Rocky hunting, on a percentage increase basis this was our best performing segment in the first quarter as the cold winter help fuel demand for our insulated and waterproof products. Our retail partners ended the season with very clean inventory levels, which along with compelling new product launches for this fall have us optimistic that we are well positioned to drive strong gains for the category over the entire year.

Last year we spent a great deal of product development and marketing resources to reinvigorate this category. We excited our dealers at the shooting and hunting outdoor trade show, the short show in January where we rolled out the fall 14 line. But also experienced a good deal of – at once demand for our spring turkey hunting product line. The retail sales are up which has been exceptional.

This would also help that Field & Stream magazine named Rocky best of the best in the hunting apparel category in the January edition. Prior to fall we will conduct an aggressive direct program targeting 200,000 households with known series hunter occupants.

Looking at our commercial military business, there are number of highlights from the first quarter have us much more positive about this business than a year ago. First and foremost sales grew approximately 22% driven by solid gains in the Army and Air Force exchange channel were demand for our popular S2V and C4T boots has picked up significantly, following the challenging selling conditions we experienced throughout much of 2013 due to sequestration and throughput draw downs.

We recently began shipping our newest product the C5 Combat boot an initial sell-through has been far better than our expectations. The C5 provides the service member with an extremely light weight offer coupled with the functional multi-directional outsole that can be worn in theater.

And lastly it was recently announced that variants of our very popular S2V boot a version specially developed the Jungle Warfare will be tested by an operational units for field performance. Finally, with regard to the newest wholesale brand in our portfolio Creative Recreation this was the first quarter of our operating the business. We are pleased with the progress we’ve made integrating the pieces of their organization moved over in the transaction and we are encouraged by conversions with major retailers about the strength of the brand.

As a reminder these are accounts that haven’t been able to target in the past such as Barneys, Nordstrom, Bloomingdale, Journeys and (indiscernible) to name a few. Therefore, we are very excited about the opportunities that Creative Rec represents for the company; especially within this much larger casual footwear market.

As expected, we are still working through some of the supply chain kings that impacted the business prior to the acquisition. That said, we feel very confident we are on top of it. And that Creative Recreation remains on track to hit the sales and profit contribution we budgeted for 2014. Longer-term believe that the brand will benefit from our sourcing and logistics capabilities and access to capital to deliver sustainable sales and earnings growth.

One other issue regarding wholesale, the aforementioned seeding program, this national retailer has agreed to expand their brand offering from just Georgia Boot to include Rocky and Durango. This means by the end of this year, we will go from three styles to seven styles in outdoors and will be testing another ten styles regionally. In Q1, to help accommodate this expansion, we help the account rationalize a markdown that current assortments.

Now turning to our retail segment, sales were up slightly as gains from the customs at kiosks and branded websites helped to offset the reduction in mobile stores, which was part of the final phase of our multi-year retail transformation. During the first quarter, we placed an additional 150 kiosks on top of the 284 in the field to start the year. Helping drive a 41% sales gain for the program and an improved operating performance for the entire retail segment. We are currently ahead of schedule to add a total of 500 new kiosks in 2014.

The other major initiative within retail is to drive more volume through our direct-to-consumer eCommerce channel, which was up double-digits in Q1. This task that got underway in earnest late last year. When we moved rockyboots.com to a new platform run by Demandware, which has increased the speed of our sites, including content delivery and has it significantly enhanced the overall consumer experience. We recently transitioned georgiaboots.com and durangoboots.com to the demand where platform also.

And we roll out responsive design that is the ability to format what the customer sees on their device depending on the type of device it is viewed on. So where the consumer visits our sites on a PC, tablet or mobile phone their experience will be optimized enabling the higher conversion rate. As I just outlined there are a lot of positives from the first quarter we very encouraged by the strong sales momentum we are experiencing and believe we are well positioned to further capitalize on the opportunities we are creating to out product, marketing and distribution strategies.

I’ll now turn the call over to Jim.

James E. McDonald

Thanks David. Net sales for the first quarter increased 22.5% to $65.8 million, compared to $53.7 million for the corresponding period a year-ago. Wholesales for the first quarter increased 26.4% to $53.1 million compared to $42 million last year. We had a $11.1 million increase was driven by a 16.8% increase in our legacy brands. Retail sales for the first quarter increased to $11.1 million compared to $10.8 million a year-ago while military segment sales increased to $1.6 million versus $0.9 million for the same period in 2013.

Gross profit in the first quarter was $21.9 million or 33.2% of sales compared to $18.7 million or 34.8% of sales for the same period last year. The 160 basis points decrease was driven by a combination of factors. They included lower wholesale margins primarily due to the aforementioned seeding program. We expect the tailwind to ease as we get into the back half of the year. First quarter gross margin were also down due to an increase in military segment sales, which carry lower gross margins than the other segments. As well as the shift to our web based retailer platform which carries lower gross margins then our previous mobile store structure at lower operating expenses as well.

Selling, general and administrative expenses were $20.5 million for the first quarter of 2014 compared to $17.2 million a year ago. The $3.3 million increase in SG&A was driven primarily by additional expenses associated with the Creative Recreation brand which was acquired in December 2013. Higher variable selling expenses resulting from the sales increase and higher advertising expenses to enhance awareness of our brands. As a percentage of net sales SG&A improved 80 basis points, the 31.2% from 32% a year ago driven by leveraging expenses on higher sales.

Income from operations was $1.3 million or 2% of net sales compared to $1.5 million or 2.8% of net sales in the prior year period. Net income was $0.7 million or $0.10 per diluted share compared to $0.9 million or $0.12 per diluted share a year ago.

Turning to the balance sheet, our funded debt at March 31, 2014 increased to $36.6 million from $20.3 million at March 31, 2013, primarily due to additional borrowings to fund the Creative Recreation acquisition. Inventory increased 14.7%, or $10.1 million to $78.3 million at March 31, 2013, which included approximately $2.5 million in Creative Recreation inventory, compared with $68.3 million on the same date a year ago. Based on our current sales momentum and fall order book, we feel comfortable with our inventory position as we head toward our busier second half selling season.

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

David N. Sharp

Thanks, Jim. Overall, we are very pleased with our start to 2014 with our acquisition of Creative Recreation, investments in product developments and demand creation, and the transformation of our retail division, the pieces are implies to grow this business. We are also pleased with the initial performance of the Creative Recreation brand which provides us with a viable platform to penetrate the broader casual for wet market. We are committed to investing in our brands to drive sustainable growth. The initiatives that impacted the first quarter profitability the seeding program with the key retail partner to funding of additional advertising and the startup costs at Creative Recreation will yield improved profitability particularly in the second half of the year and beyond and greater shareholder value over the long-term.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen at this time we’ll be conducting a question-and-answer session. (Operator Instructions) Your line is now open. You may proceed with your question.

Unidentified Analyst

Hello, can you guys hear me?

David N. Sharp

Yes.

James E. McDonald

Yes.

Unidentified Analyst

Okay, sorry I didn’t hear them announcing. I got a few questions; let me start with the seeding program I just want to make sure I understand this correctly. So through the national retailer probably you guys have been doing business with I guess for a while. So you are adding styles to that retailer and that already occurred in the first quarter and it build to the year and I just want to make sure.

David N. Sharp

No, we haven’t shipped any new styles yet. We shipped some current styles to replenish current inventory levels.

Unidentified Analyst

Okay.

David N. Sharp

That reduced margins to help them liquidate their inventory position and frankly our inventory position. As they reset, and the reset – transpiring the third and fourth quarters. It will take us from currently three styles to seven styles in all stores. And there will be testing 10 styles, another 10 styles regionally by the end of the year. So it really kicks in Mitch you know in the second half of the year.

Unidentified Analyst

Got it.

David N. Sharp

And it really sets up nicely for 2015.

Unidentified Analyst

Okay, and then Jim with the margin impact on the quarter as you helped rational – help them nationalize sort of an inventory what was that again and did you say that in your comments I didn’t know you guys are just in touch with it.

James E. McDonald

But, we had a 160 basis point decrease in our margin and that was just about half of that was related to this. So what’s happening Mitch is in the first half of the year, we experienced most of the cost of this and we’ll get most of the benefit in the second half of the year.

Unidentified Analyst

Got it. Should we see a similar negative impact on gross margin in the second quarter or was most of the inventory rationalization taking place in Q1?

James E. McDonald

I would say, it will be pretty similar to the first quarter maybe a little bit wider, but pretty closer to the first quarter.

Unidentified Analyst

Got it, okay. Thank you for that. Second question just on your fall order book, I would imagine at this stage it’s pretty well complete, could you just maybe provide a little bit more color on it. I don’t know if you care to kind of give us sense is to what the year-over-year increases or maybe talk a little bit about the order book in terms of some of your key segments or I suspect again it’s probably pretty solid, but is there anyway that you can kind of elaborate on that.

James E. McDonald

Yes, it’s very solid, and it’s usually passed out over delivery dates and so the later delivery dates susceptible to cancellation based on weather. But as it sets right now we’re extremely pleased with where it is very strong double-digit gains really across the board in all segments.

Unidentified Analyst

Okay, great that’s good to hear. Jim just in terms of the gross margins by segment on the quarter do you have any of those?

James E. McDonald

Mitch, wholesale was 31.3, retail was 45.2, and military was 13.2.

Unidentified Analyst

Okay, what was the Creative Rec impact on the wholesale gross margin?

James E. McDonald

It really was the kind of neutral there…

Unidentified Analyst

Okay.

James E. McDonald

Significant portion of there is with the international business, which has lower gross margins, but not a lot of that SG&A associated with it.

Unidentified Analyst

Okay. And then just maybe in broad strokes, can you talk a little bit about kind of where you expect sales and margins to flow through the year I know coming off of Q4 you guys are pretty positive on – and how the year was setting up, its sounds like if anything you have more confidence today even that then you did then. So just in terms of kind of maybe how the business sets up wholesale versus retail and kind of just margins across the business I mean, I know you are not providing earnings guidance, is there any kind of P&L inside that you could provide to help us model out the year?

James E. McDonald

I think Mitch, on a margin standpoint, margins in the second quarter will be similar to where they were in the first quarter, even on a segment-by-segment basis that would be pretty similar and then they will start to improve as we move to the back half of the year both in wholesale and retail. And I think for the year in total our margin will be up, well some improved margins in total and on most segment basis, other than military which will stay right around where it’s out now.

David N. Sharp

And then on sales Mitch I think we are comfortable at this point talking in the 10% to 12% range for the legacy brands.

Unidentified Analyst

Got it.

David N. Sharp

And we still see Creative Rec in that $18 million to $20 million.

Unidentified Analyst

Yes.

David N. Sharp

Yes.

Unidentified Analyst

Okay. That’s very helpful, great to hear. Thanks and good luck.

David N. Sharp

Okay, thanks.

Operator

Thank you. (Operator Instructions) Our next question is coming from the line of Mr. Mark Cooper with Pacific Ridge. Your line is now open. You may proceed with your question.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Good afternoon. And thanks for taking the call there Jim. On the margin picture that Mitch just asked about historically we’ve been anticipating that the 30 – the north of 35%, 36% range gross margin is attainable here in the company. I know we’ve talked about that in the past. Is that what you are anticipating getting back to here by the second half of the year, you suggested there is going to be some expansion that we should see at that time?

James E. McDonald

Yes, I think in total will be – for the back half of the year will be back to hopefully, certainly above the 35% I’m not sure we’ll get to 36%, but it will be for the back half – back more to the 35% and then and our – our retail margins will begin to improve as we do more of our B2C business versus orderly high business and now that have substantially higher margins in orderly high business does.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Okay. And then the is it longer term, can you see the gross margin are said in other way let say the operating margin of the business, cannot still settle around get up to the 7% range is that out of the question in the marketplace today or is that still something that I think you can get?

James E. McDonald

We certainly feel like we can get to 7% and hopefully a little north of 7% and certainly north of 7%.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Okay. And a bit of a housekeeping item here, do you have the – although I can see some of it from the balance sheet here. Do you have the cash flow and the CapEx number for the quarter?

James E. McDonald

Yes, the cash flow was – we generated from our income – cash from operations we generated $5.8 million.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

$5.8, okay.

James E. McDonald

Yes. And the CapEx was $3 million.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

$3 million and still how much of the, you might have addressed this, but how much of that increase in the receivable on the inventory line as a result of the acquisition or is it…

James E. McDonald

In the inventory it’s $2.5 million of the increase and in the receivables it’s in the neighborhood of probably around $2 million. I don’t have that exact number, but it’s about $2 million.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Okay.

James E. McDonald

So our increase in sales in the quarter was $12 million, $13 million and our receivables went up $10 million. So our aging is starting to prove on those.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Okay, did you anticipate that should continue to improve?

James E. McDonald

Yes.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Okay.

James E. McDonald

We’re also trying to improve the terms in our inventory. So we anticipate to generate – hopefully generate some cash from our inventory this year also.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Okay. And then one last question here I know that you’ve talked about your business looking at the sales numbers, looking at the first half and the second half and last year that was some in that June period you had that tremendous comparison from June of 2012 on the wholesale side I think it was north of 30% kind of sales increases.

James E. McDonald

Right.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Can you remind us what generated that?

James E. McDonald

Sure, in June of 2012 we had a major power outage here in Ohio that affected our second quarter 2012 shipments because we couldn’t ship for the last two or three days of the quarter. So those sales fell into the third quarter of 2012. And so if you look back last year 2013 we had a great sales increase in second quarter. But then and then sales decreased, but looking at the two quarters together they were still with an increase, but not to that level. So I guess what I’m saying in 2013, 2013 was the normalized year.

Mark Daniel Cooper – Pacific Ridge Capital Partners LLC

Yes, okay all right, well that’s great, thanks a lot for taking the questions.

James E. McDonald

Sure.

Operator

Thank you. Our next question is coming from line of Mr. Alexander Renker with Sidoti & Company. Your line is now open. You may proceed with your question.

Alexander Renker – Sidoti & Co. LLC

Good afternoon.

David N. Sharp

Good afternoon.

James E. McDonald

Go ahead.

Alexander Renker – Sidoti & Co. LLC

Just a quick question how much of the 20% SG&A growth was attributable to the sales growth versus Creative Rec expenses other investments that you expect to see pay dividends later et cetera.

James E. McDonald

The sales up $3.3 million about a third of it was related to the sales growth the variable selling expenses, so a little over million.

Alexander Renker – Sidoti & Co. LLC

Okay, so that’s kind of the run rate that we should think about for later quarters in the year?

James E. McDonald

Right, usually our variable expenses, selling expenses run about 15% of sales I’m not sure commissions and handling and freight charges.

Alexander Renker – Sidoti & Co. LLC

Okay, fantastic thank you.

James E. McDonald

You bet, okay.

Operator

Thank you. Our next question is a follow-up from the line of Mitch Kummetz with Robert W. Baird. Your line is now open. You may proceed with your question.

Mitch J. Kummetz – Robert W. Baird & Co., Inc.

Yes, just a quick follow-up on the seeding program, I just want to tie that back to your sales outlook on the legacy business. So if you are seeing 10% to 12% that kind of run the math I mean it looks like maybe $25 million to $30 million of additional legacy sales in 2014, what do you think the contribution will be from the seeding program particularly as it hits in the back half I mean you are talking about a couple of $3 million or is it more or less than that?

David N. Sharp

It’s a little bit more than that, it’s more like $5 million.

Mitch J. Kummetz – Robert W. Baird & Co., Inc.

Okay, all right. Great, thank you.

David N. Sharp

You bet.

Operator

Thank you. Ladies and gentlemen, we have reached the end our question-and-answer session. I would like to turn the floor back over to management for any closing remarks.

David N. Sharp

Okay, well thank you gentlemen for joining us today. We look forward to a good quarter in Q2 and speaking to you in 90 days from now. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful afternoon.

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