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Rocky Brands, Inc. (NASDAQ:RCKY)

Q3 2010 Earnings Call

October 21, 2010 04:30 pm ET

Executives

Brendon Frey - IR, ICR

Mike Brooks - Chairman & CEO

David Sharp - President & COO

Jim McDonald - EVP, CFO & Treasurer

Analysts

Mitch Kummetz - Robert W. Baird

Reed Anderson - D.A. Davidson

Operator

(Inaudible) 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 the 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

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, risk and uncertainties which may cause actual results to differ materially. We assume no obligation to update such statements. For our complete discussion of the risk and uncertainties, please refer today’s press release and reports filed with Securities and Exchange Commission including Rocky’s Form 10-K for the year ended December 31, 2009.

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

Mike Brooks

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

We are very pleased with our third quarter results which followed a much improved first half of 2010. Over the past two years, we have detailed the number of changes we have made through our operating platform which has helped drive our enhanced profitability and report our best earning results in more than 16 quarters.

These have included restructuring our retail business, rightsizing our headcount and improving the efficiency of our company operated manufacturing facilities. During this time, we also undertook the task of recapitalizing the company. A process included a successful secondary offerings in May from which we used proceeds to pay down in portion of our high interest senior term loan and just yesterday we finalized our new credit agreements with PNC Bank. Jim will go into more detail on this shortly, but this will complete the current recapitalization and significantly reduce our interest expense going forward.

While a good deal of attention has been focused on cost side of a business, we have and we will continue to invest the time and resources to expand our top line. I think, something that has gone lost this past few years as everyone has been focused on expenses, given the challenging economic conditions; there is a powerful portfolio of brand we continue to operate.

David will discuss growth plans in more detail shortly. But I want to spend a few moments reviewing what drove our solid sales increase this past quarter. Within our wholesale division we experienced strong gains in our work segment led by our GEORGIA BOOT and our Rocky Brands. These increases were driven by better weekly sell through rates of our product lines throughout our strong network of independent accounts and national retail chains.

In 2010, we have introduced several new and innovative work products into the market and the response from customers have been very positive. We have been successful at leveraging GEORGIA BOOT and Rocky’s long history of authenticity to gain market share with updated boots that are lighter, more comfortable and more durable.

These are very important features when our targeted consumers are evaluating their footwear needs and purchases. Our duty segment also posted solid growth in the third quarter as we continue to win business outside the base business Centralized Military Procurement System. Demand for our Special Forces Rocky S2V boot continues to grow and we have quickly added resources to capitalize on this new sales channel which includes the Army and Air Force exchange services for a while.

Lastly, our western segment are only up modestly this quarter. We are encouraged by the early reach on our recent brand extensions under our Durango, line. Utilizing our efficiency in creating light weight footwear we have developed what we believe is the lightest western boot in the market and we are excited about the future potential of this compelling new collection. As we move into the fourth quarter and look up to 2011 we expect the recent sales trend we experienced will continue to drive our top line expansion. Jim will now review the financials and David will discuss our growth plans in more detail. Jim?

Jim McDonald

Thanks Mike. Net sales for the third quarter increased 12.3% to $74.8 million compared to $66.6 million for the corresponding period a year ago. Wholesale sales for the third quarter increased 9% to $59.4 million compared to $54.5 million last year. The sales increase was driven by a 15.5% gain in our work categories with our ultra brands Georgia boots and Rocky increasing 12% and 56% respectively, partially offset by a 35% decline in our licensed brand Dickies.

Our Duty sales also grew nicely, up 18% in the third quarter, while our western sales increased 2% and our Hunting sales decreased 6%. Retail sales for the third quarter were $11.1 million compared to $11.5 million a year ago. Finally, military segment sales were $4.3 million versus $600,000 for the same period in 2009. The increase in military sales was driven by shipments of footwear under our contract with the GSA that was announced in August 2009 and began shipping late in the third quarter of last year.

Gross profit in the third quarter was $27.2 million or 36.4% of sales compared to $24.7 million or 37.1% of sales for the same period last year. The 70 basis point decline in our gross margin was driven by the increase in military sales, which carry lower gross margin than our wholesale and retail businesses.

Selling, general and administrative expenses were $19.2 million or 25.6% of sales for the third quarter of 2010 compared to $18.6 million or 27.9% of sales a year ago. The increase is primarily due to additional selling costs and incentive accruals, which were partially offset by decreases in other expenses. Income from operations increased 31.1% to $8 million or 10.7% of net sales for the period compared to operating income of $6.1 million or 9.2% of net sales in the prior year.

Interest expense decreased $1 million or 50% to $1 million for the third quarter of 2010. The decrease is the result of debt reductions over the past 12 months combined with lower interest rates compared to the same period last year.

Net income for the third quarter increased approximately $1.9 million to $4.7 million or $0.63 per diluted share compared to net income of $2.8 million or $0.50 per diluted share in the third quarter of 2009.

Turning to the balance sheet, funded debt as of September 30, 2010 decreased 36% or $30 million to $53.4 million compared to $83.4 million at September 30, 2009. Inventory decreased 7.6% to $62.9 million at the end of the third quarter compared with $68.1 million on the same date a year ago.

Finally, as Mike mentioned earlier, yesterday we closed on our new credit facility of PNC Bank. We filed an 8-K earlier today that contains the full details of the loan agreement, but I’ll quickly review some of the highlights of this transaction.

It’s a five year agreement with availability to borrow up to $70 million, so it secures the Company’s financing out until 2015. The interest rate is very favorable at LIBOR plus 1.75%. We are locked into this interest rate through the end of the year with the ability to go as low as LIBOR plus 1.5% based on performance.

With these funds, we are retiring $11 million remaining on the senior term net loan which carries an interest rate of 11.5% and paying off the GMAC borrowings, which carry an interest rate of LIBOR plus 3%.

Based on today’s interest rates, we expect our 2011 interest expense to be approximately $1.5 million compared to an expected interest expense of $6.8 million in 2010. Including our 2010 projection is of one-time non-cash charge of approximately $1 million associated with the deferred financing costs related to the repayment of debt that will occur in the fourth quarter.

We have obviously made significant progress reducing our debt level, not only this year but over the last four years as well. If you look back to 2006 to 2007 our annual interest expense in both years was north of $11 million. We are extremely pleased to have secured this new financing at such favorable terms. I’d note that we would not have had the access to these rates had we not completed our successful secondary operating earlier this year and pay down a portion of our senior term loan back in May.

Going forward, we are now in a much better position to generate free cash flow and again utilize for working capital purposes versus previous years when we needed to borrow the majority from our credit facility.

David will now update you on the growth initiatives we are working on for next year. David?

David Sharp

Thanks, Jim. As we discussed on our previous earnings calls, we currently have four distinct growth initiatives. The first involves 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.

First, I’ll touch on the brand and line extension of our Georgia, Durango and Rocky brands. This is the fourth consecutive quarter that our sales of Rocky and Georgia work boots have increased in the strong double digits.

As Jim just highlighted, in the third quarter we grew sales of Rocky work boots more than 55% versus the prior year quarter period. Just as impressive, with the 17% increase in our Durango business in the quarter versus the prior year quarter.

With the core of these impressive results is our more frequent and highly streamlined product introduction schedule. As our competitors continue to operate with one or two new product introductions each year, our roll-out calendar now includes four introductions.

In this slight less than retail climate, the sales increase is evidence that our customers have an appetite for this calendar and further validation that we are on the right track is the fact that year-to-date 26% of our wholesale sales have been from products introduced to our retail customers this year. Last year in 2009, only 13% of our sales were from products that were introduced in that year.

Offset by these new products, shipments to our three major traditional farm store buying groups are up from 12.1% to 33.4%. We’re also capturing new customers. We recently shipped Nordstrom four styles for a test in 10 Northwest stores.

Further, we now have 55 independent shoe stores testing our giant by Georgia brand extension along with the testament from DrJays in New York. Continuing with this frequency and focus thing, this coming weekend we have a national sales meeting where we’ll unveil an exciting new Rocky branded products called Lawn Range which bridges all four product categories that is Work, Western, Duty, and Outdoor. As its name suggests, these products will be guaranteed durable as well as comfortable. The warranty will be 60 days for comfort, a 180 days for outsold durability and its methodic in search that will break down will replace it for the life of the product.

We believe that this product introduction will capture the essentials of the industry and will become the new standard in these categories. While our retailers represent all categories, our consumers will be captivated by the broad but focused display around long product concept.

Our second initiative, capitalizing on the growing popularity of our military boots is just starting to bear fruits, now growing at a very strong pace with sales raising nearly twice that of 2009. The army networks exchange service business has challenged our supply change as the growth rates have exceeded our forecasts. We have responded with retasking production resources to achieve spare capacity to fill current demand.

Longer term, demand will be met with reallocating resources in our Puerto Rico manufacturing facility. We continue to invest in and build our commercial military business with new products. Those products include basic military combat footwear with improved comfort features, and an another fast-growing category, featherweight boots that soldiers wear when traveling and training, which are not meant for wear in theatre but needs uniform requirements. Overall, three new styles were introduced in September, which had normal effect on Q3 results, which should yield a positive impact on Q4 sales.

Now turning to our third initiative of customer segmentation, this continues to serve us well. Perhaps the largest benefit of this initiative has been the streamlining of processes enabled by our business-to-business Rocky Brands connects website, where our highest customer served dealers can bypass our customer service department and find products and delivery information and place orders. Starting with modest sales of under a $100,000 in January of this year when we launched the site, we met a major milestone last month in September, bypassing $1 million of sales in that month.

As we’ve mentioned on prior calls we can attribute some of the reduction to our day sales outstanding for this set of customers, they’re now incentivized to pre-pay their shipments with a credit card. Another part of the segmentation initiatives involves loyalty programs for our high growth potential customers. We’ve seen a growing interest in this program and next year we’ll focus our efforts on incentivizing these customers to buy across our brands and product segments, not just to grow within a brand. This is why we believe Rocky Brands have significant unrealized potential. The great deal of this initiative will be managed with customer relationship management software which we’ve used successfully in our retail business over the past two years and which we have customized for our wholesale business specifically to aid with this initiative.

Our last initiative is enabling international growth of our Georgia, Rocky, and Durango Brands. As you may be aware, there is a great deal upside for us globally and we’ve been focused on developing this business through a network we experienced in visible distributors.

In the third quarter we continue to build on our prior successes, through September we shipped $6.1 million internationally versus $4.6 million in the same period last year. We added two distribution agreements in the UK, five in Europe and one in the Caribbean. We also have agreements pending in Japan and Israel.

In closing, we are pleased to report on these growth initiatives and our significant results. During 2011 we’ll broaden and deepen these initiatives as well as bring new focus on optimizing inventory levels, leveraging customer relationships to sell more customers, all of our brands and continue to leverage our technology investments to grow operating income. I’ll now turn the call back to Mike for some closing remarks.

Mike Brooks

Thank you, David. Our third quarter and year-to-date performance is very rewarding. During the past several years we have faced a number of challenges both internal and external, and tackled them head-on. Today’s financial results underscore our efforts to create a more efficient [realization], strengthen our balance sheet and take advantage of our core competencies and portfolio of popular brands to expand our market share.

While we are certainly pleased by the recent financial improvements we have delivered, we are committed to building on our current momentum to drive those future gains across the Board. We believe there are many growth opportunities still in front of us and we are continuing to work hard at maximizing the full potential of this business. We look forward to updating you on our progress when we report our year end result in February. With that operator, we are now ready to open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from Mitch Kummetz from Robert W. Baird.

Mitch Kummetz - Robert W. Baird

Actually, I have a variety of questions. I’ll just jump into them. First on the work business, David, you mentioned that you’ve seen some pretty strong results there now. I think you said four quarters in a row. So, does that business get tougher as you anniversary that or do you still feel good about kind of the new product that you have in place, and the new calendar that you expect continued acceleration of that business or how do you view work at this point?

David Sharp

I think, Mitch we can continue to sustain the different growth we’ve seen, particularly this year with 25% of the products being new to those customers. So, if it clicks which we are seeing clicking that can help us fill it in, you know how the business is. They sell it there and they buy it there, and they sell it there and they buy it. So, we would expect to benefit from that going forward.

Mitch Kummetz - Robert W. Baird

And let me ask you about the hunting business, which was down in the quarter. Is that a reflection of the fall pre-books not coming in very well, or is that more a reflection of some weak in-season orders, maybe due to some warmer-than-expected weather, or how should I think about that?

David Sharp

I think it’s the latter. We haven’t had to fill in the activity that we had last year. Last year we got really cold wet weather early since the anniversary. And there was one or two programs that we delivered late, shifting the quarters. So, we left dollars on the table, Mitch, we were late in delivering a large program, actually our facility in Dominican on a timely basis, but many of the components were sourced in China. So that was a part of it.

Mitch Kummetz - Robert W. Baird

Are those dollars you pick up in Q4 or do you lose them?

David Sharp

Well, that’s a really good question. We are trying to pick them up in Q4, and but it’s difficult. That window is pretty tight and we won’t pick it up dollar for dollar. I don’t believe we’ll pick up dollar for dollar. We haven’t taken a lot of bets on inventory in that category this year. We are very focused on growing the work business.

Mitch Kummetz - Robert W. Baird

And then on the Military piece, those numbers came in better than expected, and it sounds like demand outstripped supply due to some constraints there. I mean does that business continue to build as we go forward?

David Sharp

Now what we were trying to explain in our written piece was of course we are still working on the GSA contract and we know what we have to build everyday, every week, every month, and that’s pretty simple. We did not expect, we have had good results for almost a year and a half on this S2V Special Ops boot, but as we move to distribute in the US through the conventional PX system, we just got a little overwhelmed. We didn’t plan and they don’t forecast and we didn’t plan enough. So we’ve been chasing that and we see no reason that we will not continue to increase production and increase sales over that product over the next year.

Mitch Kummetz - Robert W. Baird

Okay. But does the GSAP start to fall off then?

Mike Brooks

It does Mitch, right now we are through this fourth quarter; we are waiting for a new commitment from them which we do not have. So yes the GSA will fall off that lower margin. The boot I’m talking about is S2V is a Rocky full margin boot.

David Sharp

Mitch, the S2V boot as Mike spoke about, that’s actually reported under our wholesale segment, it’s a commercial boot. What’s under our Military segment is actually the bid business. So that business in fourth quarter after that’s getting any more business, which we don’t anticipate for the fourth quarter, it will be roughly $1 million.

Mitch Kummetz - Robert W. Baird

And then just a few quick other ones, on your retail business, it looks like the declines are starting to moderate there and I know, Jim, off the last call, you talked about maybe flat to down slightly in the back half. So I mean, do you expect those declines to continue to moderate in the fourth quarter or maybe even get to flat or up a little bit in Q4, based on anniversary and some getting rid of the trucks last year and switching to the web?

Jim McDonald

I think we were basically flat in the third quarter or $400,000 difference. So I would anticipate it being similar to that as we move into the fourth quarter.

Mitch Kummetz - Robert W. Baird

I know your gross margin was impacted by the size of the military business. But could you talk about the overall gross margins for your operating segments for the quarter? It sounds like the wholesale was pretty good.

Jim McDonald

The wholesale was up 40 basis points, which I think we mentioned in the earnings release in Mike’s opening comment. So, that was up 40 basis points and the retail was actually up about 30 basis points also. So, they were both up, it was strictly the blend of military product with our military coming in at just over 15%.

Mitch Kummetz - Robert W. Baird

Okay, and then last question on the SG&A. I noted on the last call, you talked about advertising coming in. I think you said it would be up $2 million in the back half versus last year. It didn’t sound like you saw much of an increase there in Q3, maybe I’m wrong about that, but are you still expecting that to increase in the fourth quarter then?

Jim McDonald

Yes, still expecting some increase over last year.

Operator

Thank you. (Operator Instructions). Our next question comes from Reed Anderson from D.A. Davidson.

Reed Anderson - D.A. Davidson

Couple of questions, obviously, given the financial condition and how well things have improved, et cetera, as you kind of look into next year, Mike, you’ve had a lot of success with new product and compressing that cycle of rolling out new product, et cetera. Is that an area you want to continue to invest in, whether it’s people or programs? Just what are your thoughts as we look at next year to kind of keep this momentum going on the product side?

Mike Brooks

The short answer is that we’ve got this financial monkey off our back and it’s taken us a long time but we’ve digested the acquisition that’s kind of put us in this position. So I really feel good about the flexibility we have with our new bank and our lower census rate gives us a lot breathing room. It’s all about product, innovative new product and branded product. We are acting premiums for our products and you have to have new fresh innovative product we talked about light weight, flexible, durable. Those will be the drivers and we need a little help from the economy. So we’re going to get everything that we can help control.

David Sharp

Well, to your question regarding increased costs, we feel what we can do a lot more business with the infrastructure that we have. We have a lift in sales into some people, we’ve got the product development infrastructure, we got the customers, we just need to focus and sell those customers more stuff. We have compressed the frequency but we’ve also at the same time streamlined what we are doing. So we are doing a lot fewer things better around product developments and product launches. And I think that’s where we are seeing this lift in sales.

Mike Brooks

Thank you, David. We’ve learned. We’ve rightsized upto those people, we are not going to run out and we’re going to reap some of our rewards over the next few years and we are going to remain diligent on cost.

Reed Anderson - D.A. Davidson & Co.

That’s good. And so really, it sounds like the shift to again the more frequent product add, actually, you just shifted the focus and retooled the way you go to market as opposed to change things in a wholesale fashion. It’s not you need to add a lot of bodies. You can keep that going. You’re smarter with your resources. Is that fair?

Mike Brooks

That’s very fair, right on target.

Reed Anderson - D.A. Davidson & Co.

And to that point about the new products, Jim, are there older lines or older models that are rolling off, or is the SKU count here really expanding quite a bit right now?

Jim McDonald

One of the things we’ve become very cognizant of as we have added all these new products is making sure that at the same we’re rationalizing older products and we are moving them out of our inventory in the right way. And right now that’s kind of top of mind for us. We are very focused on putting in systems or processes to ensure that we don’t get into inventory problems and also letting those problems with all those new products.

Mike Brooks

And I think that’s proven out, Reed, by looking at our inventory reduction over the last, certainly four quarters maybe deeper. No we are just not expanding to expand. I would tell you that our inventory is bigger today than it’s ever been.

Reed Anderson - D.A. Davidson & Co.

And then just a couple more. The comments you made, David, on loyalty programs and working with those, I noticed, I’m a Cabela’s cardholder, I saw a promotion that you and some other brands are running with them recently where by I bought Rocky Brand boots, I would get bonus points accrued to my account. Is that kind of the thing you’re talking about where you partner up with a leading retailer and find a way to really surgically address certain customers? Is that kind of what you’re getting at, or is it something different?

David Sharp

Well, yes I mean we are doing that kind of thing in some markets with some of our dealers but this is more incentive at the dealer level, incentivizing them to buy more categories from us and more brands. The more loyalty they show towards us, the more incentives that we’re willing to give up for them to do that.

Reed Anderson - D.A. Davidson & Co.

I was thinking it’s on the consumer end. It’s really; it’s with the retailer that’s the wholesale customer. That’s really what you were talking about?

David Sharp

We do partner with high profile retailers in some markets in their rewards programs, yes.

Reed Anderson - D.A. Davidson & Co.

And then last one, Mike, I mean, obviously international is small, but it’s showing some nice growth. You’ve got a number of things; it looks like you can keep that going, I mean, does it make sense that can actually accelerate kind of on a growth basis or is it too early to tell? And I’m really looking into next year.

Mike Brooks

I’m going to let David answer that. The short answer is that it’s been a strategy of ours now for a year and a half and I think we’re finally just starting to see some acceleration and it will add profits. But David can…

David Sharp

I think that it’s not unlike trying to grow businesses here in the United States. First, you’ve got to find a dealer network, a distributor network. And we’re penetrating Europe and the UK pretty nicely now, and we’re also focused on South America.

So most of these distributors that we talked about are new, they’ve come onboard in the last 18 months. And of course they’ve given the economic climate that has been just toes in the water at this point. So they’re testing our products and some of them are having nice successes & I’m sure we can businesses quite rapidly.

Operator

(Operator Instructions) We have no further questions; I will turn the call back over to the speakers for any closing comments.

Mike Brooks

Well thank you ladies and gentlemen for tuning in and we look forward to speaking with you early next year, thank you operator.

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