Rocky Brands' (RCKY) CEO David Sharp on Q1 2016 Results - Earnings Call Transcript

| About: Rocky Brands, (RCKY)

Rocky Brands, Inc. (NASDAQ:RCKY)

Q1 2016 Results Earnings Conference Call

April 21, 2016, 04:30 PM ET

Executives

Brendon Frey - ICR

David Sharp - President and Chief Executive Officer

Jim McDonald - Chief Financial Officer

Analysts

Mitch Kummetz - B. Riley

Jonathan Komp - Robert W. Baird

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands First Quarter Fiscal 2016 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. [Operator Instructions] I would like to remind everyone this conference call is being recorded.

I will now turn the conference over to Brendon Frey of ICR.

Brendon Frey

Thank you, and thanks to everyone joining us today. 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, our reports filed with the Securities and Exchange Commission, including our 10-K for the year ended December 31, 2015.

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

David Sharp

Thank you, Brendon. Joining me on the call today is Jim McDonald, our Chief Financial Officer. 2016 has got now to a challenging start due to a combination of factors that negatively impacted our wholesale segment. While we're disappointed with our first quarter results, we continue to make progress executing our strategies and further diversifying our business.

We believe by shifting more time and resources to support our growth opportunities in the casual and fashion segments with the footwear market, we will reduce the impact of weather on our top line and drive more consistent growth in the years ahead. I'll share more on these exciting initiatives later in the call. But I fist want to refresh our recent performance.

With the exception of our commercial military business, our wholesale business continue to be adversely impacted by the lingering effects of the un-seasonal weather experienced by the majority of our markets during the fourth quarter of 2015.

On a comparative basis, last year we carried the great momentum we had in late 2014 into the first quarter of 2015, thanks to frigid temperatures in January and February a year ago.

The dramatic swing in weather year-over-year when we went from record cold to record warm temperatures has created a larger material overhang in the channel, as retailers initially purchased inventory to anniversary their prior year’s sales performance.

With demand not materializing as expected, accounts came into 2016 with excess products and have essentially suspended fledgling [ph] business during the first quarter to bring inventories inline.

These actions had a pronounced effect on our core Rocky, Durango and Georgia Boot brands, which rely heavily on At-Once [ph] business during Q1. Indeed, our first quarter is the period we enter with the smallest future book and therefore least visibility into our sales prospects.

On top of weather, we continue to experience weakness in areas of the country that earlier had benefited from the oil and gas boom. We've heard from many retailers that overall Q1 business was up between 30% and 60% compared with a year ago.

Compounding all of this, our business was impacted by internal changes with certain accounts. For example, one retailer recently implemented an initiative to increase inventory turns and also reduced its older device by 10%.

Another is shifting its next move towards private label, which is negatively impacting our Georgia brand. While others are trying to reduce inventories by returning goods, we have only accommodated one account with such a return.

I should note that we believe the aforementioned issues, weather related inventory, the impact of oil and gas and changes of key accounts are systemic in our channels of distribution and are not at all unique to our portfolio of brands.

Because of our reliance on billings [ph] particularly during Q1, we make it priority to know the inventory position of our customers. Inventories have been incredibly high and consequently harmful to us for the past two quarters.

So although we are disappointed with our recent results, we're optimistic that our core Work, Western and Hunting business will improve once our customers inventories are back in balance.

Meanwhile, our commercial military business which is part of our wholesale operations grew nicely in Q1. Sales increased 30% to $5.2 million compared with the same period last year. Much of this demand is being fueled by new regulations for uniform camouflage and the introduction of our new Coyote Brown footwear. We expect the commercial military business to remain healthy for the balance of this year.

Regarding our contract of business with the US military, sales increased 122% to $5.8 million versus $2.6 million a year ago. For the remainder of the year, we seek orders per delivery of another $31.4 million with the combat boots. So in total, our sales of contract military boots should be at least $37.2 million in 2016, up a 114% from $17.4 million for all of 2015.

Additionally, we are bidding on other contracts which will maximize our production capabilities into late this year and hopefully into 2017. Accordingly, our manufacturing folks are working creatively to improve our output, so that we may fully benefit from the US military's current healthy appetite for boots.

Shifting to the diversification efforts I spoke to earlier, as you know we've been focused on extending our business into larger segments of the footwear market. The goals of this initiative are first and foremost to grow our top and bottom lines, but they will also help us to reduce our reliance on cold wet weather, while at the same time both develop a more robust futures business to mitigate our reliance on At-Once business. To this end, we are making headway broadening our lifestyle footprint with our Creative Recreation and 4EurSole brands.

Beginning with Creative Rec, the response from the latest product introductions is been very positive, looking at sales for the spring '16 season, they were up marginally. However, our gross margin on the sales increased 1400 basis points, a strong indicator that we're on track in terms of product design and relevance.

More recently we announced an exciting new partnership with actor and musician Nick Jonas. He is collaborating with us in the development to the signature line of unisex shoes to be launched in January of 2017.

In addition, he will make personal appearances at key retailer locations and will be featuring Creative Recreations fall '16 advertising campaign.

The brands has maintained with a great following among fashionable males and Nick one of those rare celebrities who crosses over and appeals to both young men and women. His collection will be focal point as we seek to build our women's business and continue to extend our brand into retail channels.

As part of the partnership, Nick has identified his favorable zone Nick's Pick's from Creative Recreations spring and summer 2016 line. He has reflected his favorite cellulite of the season and are highlighted on the Creative Recreation website.

Having Nick on board is already resonating with the creative recreation target consumer and importantly the trade is validating this initiative with increased commitment to the brand.

His collaboration with our brand will also help distribution in Europe when his cache is equally strong and where the brand has a large following. One third Creative Recs total businesses in the UK.

Looking ahead, we are in the final phases of development of our spring '17 line. We are expanding the Creative Recreation offering to include women's fashion sneakers and men's and women's casual sandals, as well as a broader range of children’s footwear due to demand from our dealer and distributor network.

Now turning to 4EurSole line expansion of the Rocky brand. We continue to have good success of building distribution. Due to our strategy of having a brand presence wherever active women shop, our online partners now include donton.com [ph] Shoebuy.com, Kohls.com and footsmart.com and QVC just informed us they will be testing the brand this fall.

Since the start of the year we've opened 20 plus new [indiscernible] brick and mortar dealers and we're seeing real orders already with many of those customers on both our Inspire Me Clogs, as well as our new Sandal line we just launched in March.

In marketing the brand we're focused on establishing awareness and engaging target consumers with meaningful content to social, digital and traditional media in supporting our dealer network.

In Q1 we grew our social media engagement close to 40% and to help launch our new Sandal line, we've engaged influential top plotters [ph] and started a multi week campaign on Oprah.com and Oprah Winfrey network television. If you are interested in learning more about the brand, please visit 4eursole.com. It’s a very interactive site with great content and information that we continue will update.

Just a few notes regarding our retail segment. As Jim will report sales were down just slightly for the period year-over-year. However, we experienced a major timing issue with our largest customer with New York City Transit Authority where we benefit from a multi-year contract.

Last year they outfitted their employees substantially in the first half of the year. This year the sales will be primarily in the second half of the year. Overall, we expect the sales to increase with the customer approximately 70% to $3 million this year.

We also shut down our operations in Hawaii and Augusta, Georgia where we had stores and mobile operations. In Q1 last year those operations accounted for approximately $300,000 of sales, which we were unable to anniversary. The only trucks we operate today are located in New York City to service the aforementioned contract.

Our emphasis on direct to consumer sales continue to bare fruit. In the quarter sales increased 17% to $2.4 million. Given the headwinds overall, we are pleased with our retail results. We were able to maintain profit contribution even with a decreasing sales.

In summary, we are confident that are strategies to expand our casual lifestyle business will contract in commercial military sales and increase the size and penetration of our direct to consumer channel that allows to rebound from the challenging starts to 2016.

While economic issues persist in certain markets and inventory levels in the channel are still about normal, we believe sales trends in our Work, Hunting and Western categories to improve as the year progresses, a trend that we have typically experienced following a warm winter.

I'll now turn the call over to Jim.

Jim McDonald

Thanks, David. Net sales for the first quarter were $57.5 million compared to $65.5 million in the corresponding period a year ago. By segment, wholesale sales for the first quarter decreased to 21% to $40.2 million compared to $51 million last year.

Retail sales during the first quarter decreased slightly to $11.5 million compared to $11.9 million a year ago. And military sales increased a 122% to $5.8 million versus $2.6 million in the same period in 2015.

Gross profit in the first quarter was $18.9 million, or 32.9% of sales, compared to $22 million, or 33.6% of sales for the same period last year. The 70 basis point decrease was driven primarily by the higher penetration of military sales which carry lower gross margins than our wholesale and retail segments. Gross margins by segment were as follows, wholesale 32.2%, retail 46.6% and military 13.7%.

Selling, general and administrative expenses were $19.1 million or 33.3% of sales for the first quarter of 2016 compared to $19.6 million or 29.9% in the year ago period. The $500,000 decrease in SG&A was primarily related to lower variable expenses associated with the decrease in wholesale sales.

Loss from operations was $221,000 million compared to income from operations of $2.4 million or 3.7% of net sales in the prior year period. For the first quarter, interest expense was $135,000 compared to $165,000 last year. Net loss for the quarter was $191,000 million or $0.03 per diluted share compared to net profit of $1.4 million or $0.19 per diluted share last year.

Turning to the balance sheet, our funded debt at March 31, 2016 was $21.6 million, a decrease of $15 million or 41% from $36.7 million at March 31, 2015. Inventory at March 31, 2016 was $84.5 million compared to $83.1 million on the same date a year ago. The slight increase in inventory year-over-year was driven by the build up of raw materials ahead of the ramp up in military footwear production.

Operator, we are now ready to take 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 with B. Riley. Please state your question.

Mitch Kummetz

Yes. Thanks for taking my questions. I have handful. So let me start with backlog, I would imagine that you have a fair amount of your fall '16 orders in hand right now, can you speak to that at all, in terms of what that looks like?

David Sharp

Its looking fairly good and we're category in particular, Western is a little soft, Hunting is also soft and the other categories are pretty flat with where we were last year.

Mitch Kummetz

When consolidated – go ahead.

David Sharp

You know, Mitch, what we're seeing really I think we should consider the part that sort of emotions and psychology is playing into what's going on right now and particularly in our – with our smaller customers and of which we have thousands, you know, that sort of play in the cold weather market, they expected to have this banner year, joined fall, winter '15 and willing to even really come close.

So many of them are not only dealing with excess inventory, they have significant reduced cash flow. And so in many cases this is not just an open to buy problem for them, it’s an open to flow problem.

But knowing that lot of this is emotional, we've seen this before what in their business improves. The – we'll see our billing business improve, and also see the future orders improve.

But we have seen some improvements and the business in April although three week isn’t a trend. So - but we feel better about sort of anniversarying April and May. We really see that as a possibility. But as we approach fall, you know, we see order dates being pushed much later than they have been in the past.

So orders that we usually have for June and July moved into August and September. We think that the – and we think this with larger accounts also that customers are hedging, you know, playing defense just in case they are surprised by another record warm winter. And - but I think we're seeing the business improve right now compared to what it was like particularly in February and March.

Mitch Kummetz

Okay. And you told this obviously skews more towards billing orders and pre-books anyways. But you mentioned the large overhang - inventory overhang on the channel and how that impacted your business this quarter.

I mean, is there much opportunity kind of this late in the season for retailers to continue to clear inventory or do you think that there is been a lot of products that’s been packed away and if there has been a lot of pack-aways does that then kind of encumber your opportunities to capture some billings as you move into the back half of the year or how do you kind view all of that?

David Sharp

Well, like I said, yes, you're right, we know particularly in the – we know that larger accounts can pack away, like they use to. They cleared a lot of the goods, but we know a large part of this is done with smaller accounts and they do pack away and they have packed away.

And we're seeing, as I said in our Hunting business, sort of reduced order book. But we do believe there is opportunity once our retailers experience better sales, and their cash flow and they are feeling now lot better about everything.

Mitch Kummetz

And so I know, I think on the last earnings call, you provided kind of preliminary top line guidance for the year and granted you have limited visibility. But I think at the time you were seeing sort of high single digit revenue growth.

It sounds like your projection on the contract with military business has gone up, I don’t maybe like $6 million. And so when you kind of role everything up, where your crystal ball stands today, what are you looking in terms of your top line expectations on the year?

David Sharp

So Jim and I have been doing a lot of work on that, particularly over the last three days. So Jim why don’t you go ahead and comment on that.

Jim McDonald

Yes, I think that with the living piece [ph] in military sales, and this is total sales [indiscernible] guard, will be more up in mid single digit range than higher single digit range, more around the 5% as we see it right now.

Mitch Kummetz

Okay. And then…

Jim McDonald

That’s through the year…

Mitch Kummetz

Right…

Jim McDonald

And I think that on the wholesale particularly side will continue to be little bit challenged here in second quarter until we move into third quarter and fourth quarter…

Mitch Kummetz

Okay…

Jim McDonald

But overall…

Mitch Kummetz

And it sounds like relative to kind of what your thinking was a few months ago that you now expect more military sales that you left, wholesale, from an earnings contribution standpoint, does that mix shift - is that a favorable mix shift?

I mean, is military, I know military carries a lower gross margin, but does not have a lot of SG&A tied to it, if all of sudden now you are expecting to do military - more military sales versus wholesale sales, does that actually help from a profitability standpoint or does it hurt you?

David Sharp

No, I think it’s probably a little bit arduous [ph] a little bit in the fact that it does have a good profit contribution, because it doesn’t have any SG&A expense. But when you look at the gross margin that we earn on wholesale and retail, rest in variable SG&A that we have, that’s a little bit higher than our 13 plus percent that we get on our wholesale - on our military products.

So if didn’t have any fixed SG&A yes, it would be a positive, but unfortunately fixed rate SG&A that we have in our wholesale and retail businesses doesn’t go away with a decrease in sales. So it is little arduous to sound.

Mitch Kummetz

Okay. And then maybe my last question, just on Rocky 4EurSole, can you just remind us how big that business is, maybe as of last year, kind of where does it stand from a profitability standpoint and any growth targets you might have for that business for this year or beyond?

David Sharp

Yes, so our plan is – and our current plans is for $1 million in sales, which is obviously the de minimis. However, you are familiar with this market and how dynamic it can be if we had the right dark fruit. So we think we got a great story here, it’s resonating exceptionally well and we think that that $1 million - we can do that $1 million and if we can a $1 million there is no reason why we won't be 3 to 5 for following year.

Mitch Kummetz

Got it. All right. Thanks, guys. Good luck.

Jim McDonald

Thanks.

Operator

[Operator Instructions] Our next question comes from Jonathan Komp with Robert W. Baird. Please state your question.

Jonathan Komp

If can first just ask a question about the wholesale business, I know when you were talking about the order pattern, you used words like emotions, in terms of how retailers plan the business in the back half.

I am just assuming how you plan your business in terms of the level of flowing [ph] inventory production that you might have ready, if you do get more normalized weather patterns and just how you view that dynamic overall?

David Sharp

Yes. So what we've done in the past Jonathan is not – it is depending on the insulation factor. So heavily insulated boots, 200, 400 grams and above. We only buy what we felt what we sell, and in all we only make what we sell. And on those that have all the season on year end of the really cold weather the 200 and 400 gram boots will sometimes buy 105% and 110%.

So you know, the bottom line there isn’t a lot of upside once we get into the season to capture something that’s moving extremely well.

Jonathan Komp

Okay. Got it. That’s helpful. And then just a bigger picture question, I know you've talked several times about the shifting of resources to the casual and fashion side of the business. Could you maybe just help conceptualize internally what that means in terms of resources and kind of what you're applying to casual and fashion versus what you previously were.

And maybe how you think about how fast that business could start to ramp and I know you have a lot of initiatives going on there. But any help there would be definitely helpful from our perspective?

David Sharp

So obviously in developing something or we brought in something like we're doing with Creative Recreation there is a lot – there is lot of work and investments in product developments and moulds, glass dyes patterns, those kind of capital investments, along with the advertising expense.

Obviously that we incur, once we get the stuff to market and help itself through, and - but in terms of a return on those and expenses and investments, we - its very met, the plan is got to be very minimal for a Creative Recreation this year. But for it to be marginal profitable, we are spending aggressively now with Nick Jonas, he is very [indiscernible] and his services don’t keep cheap.

So - and with respect to 4EurSole as you probably heard earlier when we're answering Mitch that we plan sales that $1 million obviously with everything that we're putting behind that, that will not be a - that will be loss of - be negative profit contribution.

But we believe that [indiscernible] footwear that is growing and we can have a future there. And it looks like we've got some product that’s performing at retail. We've got good place with some great retailers and its selling through pretty well.

So we're excited about both of these brands and the line extension that Rocky 4EurSole is we believe a good platforms to grow you know in the future.

Jonathan Komp

Great. And then David as you continue to get some wins on the military, the contract military side, any updated thoughts to your thinking, the sustainability of some of those contracts if that could become annual type contracts or if what you are seeing now more of a one time bump up and then back to a normalize level for that business or just any perspective on the sustainability there?

David Sharp

Yes, from what we're hearing, it seems to be a great need here and when we bumped that need up against what we know about people who play here in terms of manufacturing these kinds of boots, we think there isn’t really enough capacity to meet the military's needs in the short term, many of these contracts are multi-year contracts, they usually four or five year contracts, but renewed annually.

So we're hopeful we can get a little bit more in this year maybe and then as we swing into '17 we're feeling really pretty good about '17 also.

Jonathan Komp

Okay. Great. And then maybe two last ones from me for David or Jim. Just first any thoughts on kind of the timing and the rationale for the buyback authorization. And then secondly I noticed in the 10-K I think there was a decline in kind of the total headcounts for the company and I am wondering if you could just provide any color?

David Sharp

Yes, with regard to the buyback, you know, we're actively taking stock out at this point, we have that in place. To date we haven’t bought any back, we have a program in place where we could buy in a close period, unfortunately we weren’t able to buy that period. So we'll continue on with that program, provided we can buy a packet value that we feel is appropriate.

With regard to the headcount reduction, most of that headcount reduction came in our facility in the Dominican Republic where our production was down from where it was the year before. So that’s where most of the reduction in headcount came from.

Jonathan Komp

Okay. Great, very helpful. Thank you, guys.

David Sharp

Thank you, John.

Operator

[Operator Instructions] There appear to be no further questions at this time. I'd now like to hand the call back over to management for closing remarks.

David Sharp

Okay. Well we thank you for your time. We'll be working hard here over the next quarter to increase sales and meet targets. Thank you for joining us today.

Operator

This concludes today's teleconference.

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