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Rocky Brands, Inc. (NASDAQ:RCKY)

Q2 2010 Earnings Call

July 28, 2010 04:30 am ET

Executives

Brendon Frey - ICR

Mike Brooks - Chairman & CEO

Jim McDonald - CFO & Treasurer

David Sharp - President & COO

Analysts

Mitch Kummetz - Robert W. Baird

Reed Anderson - D. A. Davidson

Operator

Good afternoon ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands second quarter fiscal 2010 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 we’ll now turn the conference over to Brendon Frey of ICR.

Brendon Frey

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, risk 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 the reports filed at Securities and Exchange Commission including Rocky’s Form 10-K for the year ended December 31st 2009. I will now turn the conference over to Mr. Mike Brookes, Chairman and Chief Executive Officer of Rocky brand.

Mike Brooks

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

We’re very pleased with our second quarter performance, particularly the dramatic improvement in our bottom line versus the same period a year ago. During the past two years, we’ve undertaken several strategic initiative to right size our infrastructure and better position the company to deliver profitable growth on a consistent basis.

This is enabled, this is entailed lower in our corporate overhead improving the efficiency of our supply chain, which includes our company-operated manufacture facilities, restructuring our retail operations and reducing our debt levels. While we still have work to do, our second quarter non-GAAP EPS of $0.17 is evident of the positive progress we have made, toward achieving our objectives.

Specific to the second quarter, our wholesale business which makes up roughly approximately 70 % of sales contributed much higher profitability versus a year ago, driven by lower manufacturing costs on a per pair basis at our facilities in the Caribbean. We currently produce about 25%of our annual inventory needs.

However, this number could increase in the future as we explore additional manufacturing options in the region in order to offset potential cost increases coming from our China suppliers. And while they carry a much lower gross margin compared to our wholesale and retail business, the increase in sales for the US military helped us better leverage the fixed cost in our factories during the second quarter.

At the same time, our operating expenses are down approximately 11% from a year ago and we are down nearly 30% from the second quarter of 2008. A good portion of the decrease is attributed to the ongoing overhaul of our retail business as we move to a more flexible less-capital intensive order and delivery method. Finally, and perhaps most importantly, we continue to significantly reduce our debt levels during the second quarter.

Using all the proceeds from our successful equity offerings that we completed in May along with availability under our credit facility, we paid off $29 million of our $40 million senior-term loan which carries an annual interest rate of 11.5%. Not only did we end the second quarter with debt levels down $51 million or 58% from a year ago, but we project, we will save approximately $3 million in interest expense per year going forward.

Jim will now review the financials in more detail and then David will discuss our growth plans for the remainder of the year.

Jim McDonald

Thanks Mike. Net sales for the second quarter increased 7.9% to $55.2 million compared to $51.2 million for the corresponding period a year ago. Wholesale sales for the second quarter increased 1.6% to $38.5 million compared to $37.9 million last year. The sales increase was driven by a 10.5% gain in our work categories with our own brands, Georgia Boot and Rocky, increasing 13% and 15% respectively, partially offset by a 25% decline in our licensed brand Dickies. At the same time, 13% sales increases in both our hunting and duty categories helped more than offset a 15% decline in western sales.

Retail sales for the second quarter were $11 million, down $1.3 million from the sales of $12.3 million a year ago. The modest decline was a result of our ongoing transition to a more direct order, direct ship program and the decision to remove a portion of our Lehigh mobile stores from operation to help lower costs.

Military segment sales were $5.7 million versus $900,000 for the same period in 2009. Gross profit in the second quarter was $90.1 million or 34.6% of sales compared to $17.7 million or 34.6% of sales for the same period last year.

Gross margins in our wholesale segment rose 370 basis points driven by the increased manufacturing efficiencies that Mike discussed earlier. However, this is offset by lower retail gross margin as a result of our ongoing transition to more internet-based transactions and the increase in sales to the military.

Selling, general and administrative expenses decreased 10.8% or $2 million to $16.2 million or 29.3% of sales for the second quarter 2010 compared to $18.1 million or 35.4% of sales a year ago. The decrease is primarily the result of reductions in salaries and benefits, bad debt expense, advertising costs and Lehigh mobile store expenses.

Income from operations increased to $2.9 million or 5.3% of sales for the period, compared to an operating loss of $400,000 in the prior year. Interest expense for the second quarter increased to $2.1 million from $1.9 million in the second quarter of 2009 as a result of one-time fees of approximately $900,000 associated with the early repayment of $29 million on our $40 million senior-term note.

On a GAAP basis, we reported net income of $0.5 million or $0.08 per diluted share versus a net loss of $1.4 million or $0.25 per diluted share. On a non-GAAP basis, excluding the aforementioned one-time fees, net income for the second quarter of 2010 improved to $1.1 million or $0.17 per diluted share.

Now turning to the balance sheet, funded debt as of June 30th 2010 decreased to 57.8% or $50.6 million to $36.9 million compared to $87.5 million as of June 30th 2009. Our accounts receivable decreased 8.2% to $40.8 million versus $44.5 million last year. This is particularly important as the decrease came during the period when sales increased 8% highlighting the improvement we have made in managing our receivables. Our inventory decreased $17.5 million or 22% to $61.8 million at the end of second quarter compared to $79.3 million on the same date a year ago.

David will now update us on our growth initiatives.

David Sharp

Thanks, Jim. While we have made good progress actually on the cost side of the business, we have also been busy implementing growth initiatives, but we are confident we will expand our market share and broaden our consumer appeal.

Let me update everyone how these are tracking and what we are anticipating will drive our top line at the back half of this year and over the longer term. As we discussed in our previous earnings calls, we currently have four distinct growth initiatives. The first involves the brand and line extension 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 and line extension; about a year ago, we adopted a new calendar for rollout of new products. In the past, we along with the rest of the industry in the western work segments had one product launch per year at the beginning of each year.

Now at Rocky Brands, we have four per year and this is paying off. Because of this new tactic, for three consecutive quarters, we have been able to manage mid-teen sales increases over the prior year in our Rocky and Georgia work boot lines and this trend will accelerate for the balance of this year and into the first half of 2011.

For example, in the third quarter, we will shift some 21 new styles of Rocky work products expanding the breadth of the line by approximately 19%. These new products have been well received, they currently constitute $3.5 million of open orders. During the last quarter call, we reported that in March we delivered new lightweight and flexible western influenced boots by Durango.

And that early sellthrough for some retailers were favorable. We are pleased that these early reports are continuing frequency and strength. In fact, the good problems to have, reorder demand is currently outstripping supply. We anticipate that we will be back in business on this collection by September and cash the important fall and winter seasons.

Many key retailers from around the United States are reporting weekly sellthrough of 10% and better on these products. We have expanded this collection in both men’s and women’s ranges and will deliver six new styles in December.

Our second growth initiative capitalizes on the growing popularity of our military boots. On our last call, we told you that we have been exploring the network of distribution outside the bid-base centralized military procurement system and we have begun to reap awards in the first quarter.

In the second quarter, we continue to see improvements of sales to this new channel. Demand for our core special force military boots is rising and part of the result developing relationships with key players in the decentralized procurement chain.

Initial rollout of stocking inventories of the army and airforce exchange service, the key military base continued in this quarter with excellent replenishment demand adding incremental sales.

Request for natural variance of our special force boots such as Steel Toe and Insulated version is creating growing incremental volume and increased channel penetration. We continue to invest in the military footwear development process, provide solutions with improved [war fighter apparatus].

Our third strategy for the customer segmentation, our wholesale division is being largely enabled by our new business divisions capabilities. While, we are focused on increasing sales through the introduction of new products and new initiatives, we are mindful that 70% of our business in our western and work footwear segment is received in the form of at once filling orders. At the beginning of this year, we embarked on a whole new initiative to incentivize our dealer network to fill into predetermined model stock on a weekly or biweekly basis.

Our business is a stock-keeping unit tied in with intensive business. If our dealers are out of stock, they miss the sales opportunity because our consumers are generally unwilling to wait for special orders. Our program is working, our best dealers are using the system, customers have our products in stock most of the time. But some residual benefits we’ve been able to improve margins and day sales outstanding with this program.

Growing our business internationally is our fourth initiative and we continue to see sales improvements with it as well. We now have six high profile distributors of our Rocky Branded hunting products serving 27 countries in Europe and Oceania.

Clearly, the casual lifestyle market in Europe is a great opportunity for us with to the American positioning of our Georgia and Durango brands. And we reported on the last call that we’ve signed two distributors on the continent and we now have a third pending to serve the United Kingdom. We remain committed to these four initiatives and look forward optimistically to grow our top line to the balance of this year and into 2011.

I’ll turn the call over to Mike for closing comments.

Mike Brooks

Thanks, Dave. 2010 has gotten off to a good start, with year-to-date sales result that have exceeded our expectations. Sales were up approximately 10% in the first six months, and could have been higher had it not been for some supply change constraint outside our control, it interrupted the flow of goods coming in from Asia.

As we head back into the back half of the year, we believe we now have a better inventory position that will allow us to capitalize on the growing demand for our portfolio of brands and products. From an earnings perspective, the combination of solid sales growth, improved merchandised margins and better operating expense leveraged enabled us to recover from a $0.45 loss in the first six months of 2009, to just about breakeven so far this year. If you exclude the one-time charges related to our debt repayment, we earned $0.08 for the period.

We continue to be comfortable that we have the right strategies in place to expand our business, while at the time drive higher profitability through our enhanced manufacturing and operating platform. We are encouraged by the positive momentum we have created and we are committed to taking advantage of our improved position in order to deliver strong results in the future and return greater value to our shareholders over the long term.

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

Question-and-Answer Session

Operator

Thank you, we will now be conducting a question-and-answer session. (Operator Instructions). Thank you our first question is from Mitch Kummetz with Robert W. Baird.

Mitch Kummetz - Robert W. Baird

Let me start just trying to get a little more color on the wholesale business. Mike, you talked about some supply constraints and then David was talking about on the Western business kind of demand outstripping supply, so Western was down, Jim I think you said 15% in the quarter, I know it was up double digits last quarter. Is that where you saw the issues in terms of the supply constraints, or was it really kind of across all of your businesses?

Mike Brooks

I think the supply constraints were really across the entire business. And on with respect to the Western business Mitch, we are now flat for the year, but we do see some upside in the back half.

Mitch Kummetz - Robert W. Baird

How do you see the wholesale business progressing over the balance of the year? It was up I think about 5% in the first quarter, 2% this quarter. It sounds like you’ve got momentum on the work side outside the Dickies, hunting seems to be trending well. There seems to be good demand on the Western. So, do you see an acceleration of the wholesale business in the back half, versus the first half?

Mike Brooks

Mitch if I may, the supply problems that I think most everybody in the footwears have in the first half of this year and troubling and difficult for the first half. We have vision of sales that we left on the table that we don’t believe are going to go away that will shift the third quarter and the fourth quarter.

As I said in my statement, it looks like we’re back in business on a much higher percentage of our inventory that we can deliver, and to answer your question, we see demand still holding fairly well across all of the categories, and that’s really a good sign. So, we’re encouraged and we believe that we will see solid sales increase in the second half of the year.

Mitch Kummetz - Robert W. Baird

Okay, that’s good to hear. And then on the retail business I know that you are r anniversarying some of your trucks being removed from the market, and does that change in the back half of the year? Does that ease up in the back half where you could potentially see some increases on your retail business?

Jim McDonald

I have some metrics on where we’re at with these assets in the field. We ended the year with 67 trucks in service and now we’re operating 60. Those were supported by 30 centers, shoe centers we call them, mini warehouses and work force team. We are employing about 240 people in that business right now, we were at 300 at the beginning of the year.

And anticipating a question about the web sales, for the full year of 2009 we were about 11% web, and we’re trending about 22% right now. Mitch, I think from a year-over-year sales decline I think in the back half of the year we’re hopeful that we can equal 2009 levels in the back half of the year, or certainly have a much smaller decline year-over-year than we had in the first half of the year.

Mitch Kummetz - Robert W. Baird

Got it, and then on the military business you’ve shown I mean year-to-date you’ve had some really good results there in terms of the revenue, and just kind of based on where the contract stand and all of that, and sometimes I lose track of that, what are the expectations for the back half of the year there?

Mike Brooks

Mitch, you got to think of the military in two pieces. The first piece is what everybody likes to talk about, and that’s the bidded business GSA in this case, or it could be DoD Department of Defense. But we will manufacture and ship less pairs because we really had to gear up for the first half of this year to get them the shoes that they needed, and we’re taxing our factory.

So I think we have left about $4 million to $5 million that we will ship the second half of the year, but what that frees up is the second part of the business that we report under duty, is premiere full Rocky margin product that we are selling everyday. And that’s growing our duty end of our business even as our Postal business is losing sales, because of cutting the postal employees. But we have some exciting full margin Rocky product that we are selling to the military in different channels, if that makes sense to you.

Mitch Kummetz - Robert W. Baird

Right, no that does. And then maybe just two last questions, one on the gross margin I mean you guys obviously showed nice improvement on the wholesale business going from the first quarter, the second quarter in terms of the year-over-year.

And you are seeing some nice improvement on the cost there, the per pairage cost, does that continue, is that sustainable going into the back half of the year, or does that change?

Jim McDonald

At this point Mitch we really have all by means purchased, and we are not experiencing and we bought them at the old prices. So we think that we are at least through the end of this year, we can hold host up prices where they are at.

Mike Brookes

From a manufacturing standpoint Mitch, we really start to ramp production up at our factories in the back half of last year. So the year-over-year comparisons will not be as great in the back half of the year as they were in the front half of this year. So, those gains won’t be a significant on a year-over-year basis. It is really starting to wrap those batteries up second half of last year.

Mitch Kummetz - Robert W. Baird

Got it, and then lastly Jim I guess a question for you on the operating expenses. You guys continue to do a great job there, actually a lot better than I was expecting in the quarter, but it seems like it was a lot of the same benefits in Q2 than you saw in Q1, so in terms of things like salaries, in advertising and what not, should those continue to benefit your SG&A, or through the back half of the year, or does it kind of flat now? I was expecting it to come as flat now in the second quarter.

Jim McDonald

I think that the salaries and wages will start to flatten out a little bit more in the fourth quarter and we really made a lot of the changes late first quarter last year and then had severance costs that ran into second quarter last year. So they still should also have decreased year-over-year. The other big thing bad debt, we took a lot of hit in the bad debt in the first half of year.

So we should have a great year-over-year to move to the second half if we did in the first half. And then the advertising costs will actually go the other way, we really under our anticipation. We had some movements, some advertising expenses for the first half of the year into the second of the year.

We are still anticipating that to be up about a $1.5 million over last year as we as far for the year. Because we took it down, we’ll return to more normalized levels. We’ve taken a lot out of that in the last couple of years in reducing expenses.

Mitch Kummetz - Robert W. Baird

You expect that to be up a $1.5 million for year. What is it through the first half of the year?

Jim McDonald

We are in first half of the year, year-over-year we’re down about $0.5 million.

Mitch Kummetz - Robert W. Baird

Okay, so you would expect it to up about $2 million year-over-year in the second half?

Jim McDonald

Yes, that’s about right.

Operator

Our next question comes from Reed Anderson with D. A. Davidson.

Reed Anderson - D. A. Davidson

Let me start up with that last question first, the incremental ad spend and obviously it’s incremental because you are basically restoring it back to what it was. But any change in mix or where that’s targeted at (inaudible) what are you doing when you are increasing that, where is that being directed?

Jim McDonald

Based on our research, the 70% of the purchase decision is made in store, we are basically spending a lot of those incremental dollars on instore displays to draw the consumer towards our product. Also with inplanting product knowledge with the retail associates that serve our consumers. Because we have highly functional technical product with features and benefit, so that’s where the incremental dollars will be spent this year.

Reed Anderson - D. A. Davidson

And then will that get you back to essentially kind of where you were before you took it down or will you still actually be lower just a couple of years ago either on a percent or how you want to look at it?

Jim McDonald

It will be where we were in 2007, 2008. And I think we are scrutinizing the spend and so easy to spend the advertising dollars, I think we are scrutinizing that much better and getting more bank for our bucks so to speak.

Reed Anderson - D. A. Davidson

Then Mike or Dave, was talking about, for example you got some new product coming out, the 21 new styles I think is what you said in Rocky in the third quarter and I guess what I was curious about that, now that you’re kind of reviving the product more regularly or however you want to look at it. From a pricing standpoint, is that a product that these new iterations are being priced a little bit higher or is the mix and that giving you an higher ASP, just some commentary Mike on what are you seeing out there from pricing?

Jim McDonald

It should not be a surprise to anybody is that prices for like product are going to be up, whether you buy it in China or no matter where you buy it, raw materials, labor everything is going up. So we have a price target in mind that we want to built product, a brand or a style too, and so we not necessarily tieing ourselves to a pricing game. We’ve got to get the right leather and the right bottom and the right look and the right balance in the shoe. If you have that, we have price points that we want play in if you may. So we don’t get too hung up on the pricing. If the product is right, the consumer will buy it.

I think the you know average selling prices are probably are going to stable for us this year, even in these introductions that price band that we have playing in five brands, but I think we can expect in 2011 that we’ll be moving up each brand will probably move up on average $10 at retail.

Mike Brookes

And we won’t reduce the quality of the shoe to try to offset a price increase. We think that would be the wrong thing to do, so David is right, we will have price increases next year we’ll probably be announcing those as we move into the fourth quarter early this year. So our customers are prepared, but new items, we have a target price range we want to hit, we build the shoe to that.

Reed Anderson - D. A. Davidson

That make sense. It’s very helpful and then last question, I had just Jim on inventories you know very well controlled and obviously maybe there’s some timing issues in there or relative to production delays or whatever, but just as we think about your inventory we get to the end of this year. Does it make sense that you are starting to see some growth in there? What’s your thought process on inventory you want to kind of carry into the meat of the season and end up the year with?

Mike Brookes

I think our current plan is for inventories to be worst flat with last year end and hopefully down slightly from where we were last year, but not significantly. I think we’ll be in pretty good shape as we move in to the end of the year. We got the big decrease in inventory during ’09, and as we get to the back half of the year anniversarying those year-over-year increases will be much more difficult decrease when it starts.

Operator

(Operator Instructions). Your next question is a follow up from Mitch Kummetz with Robert W. Baird. Please proceed with your question.

Mitch Kummetz -- Robert W. Baird

Yes thanks, I just wanted to ask about the international business. David you kind of gave an update there just talking about that that being one of your four key strategic initiatives, and you kind of ran through some of the distributors. Could you just remind me of how the timing of those coming online, and what impact did that have on the quarter? And I don’t know if you can break out what your international sales were in the quarter, and is that a bigger benefit to you as you sort of think about the business over the next maybe I don’t know 6 to 12 to 18 months? How do you expect that to play out given what you are doing there?

David Sharp

I think we are very optimistic about the international business. We actually really started on it as a strategy in ’08, and we were starting to get some legs and then the global economy, it skid. So we went through a period of 12 months where we really had no interest all. But now we’ve start to gain momentum I guess. We’re up to 6 distributors in outdoor, one of which came online Q2. And we’re up to 3 in what I call lifestyle, and one of those is coming online. So really it’s just going great.

But I think that, though specifically it’s still a small phase of business, we should end the year somewhere in the range of $2.5 million to $3 million off of, I think last year we did about $850,000. So it’s a large increase, but still a small phase of business, but these relationships take time to grow and so they can grow very dramatically once we get some momentum.

Mitch Kummetz -- Robert W. Baird

Okay and then last question from me. And I’ll go back to you David, I think you said in response to one of these questions about price increases, did you say you’re taking prices up about $10 a pair, kind of across the board?

David Sharp

At retail. Right now, there’s a lot of puffery in a lot of supplies in the supply chain. We’re looking to get back to the stronger pricing. And I think that we’re watching this very closely and we expect for this to shake out a little bit between now and the end of the year. But if we were to believe today’s numbers we’d be in the 8% to 10% range.

Mitch Kummetz -- Robert W. Baird

On the cost increases or on what you are doing with your own prices?

David Sharp

It’s only in cost increases, yes.

Mitch Kummetz -- Robert W. Baird

Okay and you think what you are doing on pricing on your end do you think that will allow you to mitigate all of those cost increases, or do you think you’ll have to bear some of that or?

David Sharp

We believe that we can improve our margins going forward.

Operator

(Operator Instructions). 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 Brookes

Thank you very much for listening in. We look forward to continue in on our progress, and we’ll report back to you in three months. Thank you operator.

Operator

Ladies and gentlemen this does conclude today’s teleconference you may disconnect your lines at this time. Thank you for you participation.

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Source: Rocky Brands, Inc. Q2 2010 Earnings Call Transcript
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