Rocky Brands' (RCKY) CEO David Sharp on Q2 2016 Results - Earnings Call Transcript

| About: Rocky Brands, (RCKY)

Rocky Brands, Inc. (NASDAQ:RCKY)

Q2 2016 Results Earnings Conference Call

July 28, 2016, 04:30 PM ET

Executives

Brendon Frey - ICR

David Sharp - President and CEO

Jim McDonald - CFO

Analysts

Jon Komp - Robert W. Baird

Mitch Kummetz - B. Riley

Operator

Welcome to the Rocky Brands Second Quarter Fiscal 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] I would like to remind everyone that this conference call is being recorded.

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

Brendon Frey

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 30, 2015.

I'll now turn the call 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.

During the second quarter our core wholesale business continued to be challenged by the lingering effects of the unseasonal weather experienced by the majority of our markets during the fourth quarter of 2015. Inventory levels in the Western Work & Hunting channels have remained unrelated since the start of the year which has impacted our reorder opportunities.

This headwind was further exacerbated in the second quarter by a soft retail environment particularly for footwear and apparel. We were able to partially offset the decline of wholesales sales through a significant gain in military sales. However, we've needed to ramp up our internal production capabilities in order to fill the triple digit increase in combat boot orders we’ve received. This pressured second quarter margins.

While we’re disappointed with our recent results, the current problems are temporary and addressable and with respect to our wholesale business, we believe the issues we’re facing are systemic in our channels of distribution and are not at all unique to our portfolio of brands but rather a reflection of our current concentration of business, reliance on seasonal weather and a target consumer whose discretionary income has shrunk over the past 10 years.

I am going to review our wholesale segments in more detail including category and brand color. I’ll then review our Retail and Military segments before Jim walks through the financials.

Starting with work footwear, sales were down high teens compared with a year ago. As you’re aware, this is the category which we rely most heavily on film business the delivery at once. So it is our most unpredictable category. However, under normal circumstances it is quite reliable. Circumstances for the last two quarters have been abnormal grossing the declines in both our Rocky and Georgia Boot branded work boots.

As we moved through the quarter, the at once components of our business did improve but still not quite in line with last year. And as we turn to the back half of the year, our backlog in Georgia Boot business has increased nicely mainly on the strength of a new collection named Blue Collar which has been well designed and engineered for the tradesmen.

Now turning to Western footwear where we continue to be hampered by the downturn in the oil patch which has been particularly difficult for Western wholesalers and retailers negatively impacting our sales in the quarter we were down mid teens versus last year between our Durango and Rocky branded Western boots.

Despite the headwinds in the quarter, we have reason to be cautiously optimistic as we gain visibility into the rest of this year. During Q2 we managed to see the substantial amounts of new product with five major accounts making a large increase with them which should pay off in severance during the third and four quarters. Further, as we spring into August our future orders are significantly higher in fact almost double where we saw them last year at this time.

Our Hunting footwear suffered the steepest decrease from a year ago due primarily to the carry-over inventory many of our accounts are trying to manage through coupled with disappointing sales of spring 2016 goods. So right now many of our retailers have large carry-over inventories from last year in the spring and are now receiving product for this fall and winter season.

So there is a high degree of anxiety in this channel with a lot riding on seasonal weather this fall and winter. One highlight in Hunting has been benefit of camel head-to-toe offerings. We expect this collection to help drive sales at retail this year.

Now to our Commercial Military business which is separate from our Contract Military segment and falls under our wholesale operations. Sales were up 40 plus percent and significantly outpaced our forecast. Our S2V product was again a standout fueled by the new Coyote Brown camel pattern for the services BDU or Battle Dress Uniform. We’ll soon our latest lightweight Trainer in the retail channels, our C7 which should provide more anticipated sales in the category.

With respect to the diversification efforts that I spoke to on our last call, we continue to make progress developing new growth vehicles that help to reduce our dependence on optimal weather. First create a recreation. We're making the brand more accessible to male and female millennials both in design and price point. Indications are positive that our strategies are on point and resonating.

In our most recent season during summer, we saw sales increase 83%. Although our sales with the brands are still under plan and short of breakeven for 2016 from a profit contribution standpoint, we believe that currently we are selling into lackluster over-inventory market which is extremely cautious right now without the open to buy dollars to onboard new brands. When the market recovers we’re well positioned to capitalize on a rebound.

In the meantime, we’ll continue to work with our retailers especially those like Nordstrom and Bloomingdale ensuring we use our brand ambassador Nick Jonas to help communicate our brand message with their customers. We’re currently harvesting orders for a spring which includes the exclusive Nick Jonas designs and this collection has been extremely well received.

Second although not yet significant in sales, Rocky for your sole continues to increase its distribution and to an important online retailers and well regarded full service shoe stores around the United States. We opened an additional 19 new bricks and motor customers in the second quarter. Additional we’re currently setting up [belt.com] joining our strong bench of online retailers including BonTon.com, Shoebuy.com, Kohls.com and footsmart.com.

And as we mentioned on the call last time, we’ll be testing with QBC in September. We’ve just completed the trip pre line and spring 2017 and our prospective and current retailers involved were very complementary about our innovative company story and differentiated upper designs. If you are interested in learning more about the brand, you should visit foryoursole.com it’s a robust site with great content and information that we continually update.

In our Retail segment despite the headwinds we were able achieve a small single-digit increase and when we compare sales to last year without truck operations that were in service last year, the sales increased a respectable 5%. Direct to consumer sales via Internet increased 12%.

Finally our Military segment which posted its highest ever quarterly revenue in Q2. Sales increased 139% to $10.7 million as combat boot shipments accelerated significantly versus a year ago. To achieve this record volume and ensure we’ve positioned to deliver triple-digit revenue growth for the full year we needed to ramp up our internal manufacturing capabilities including bringing on more workers.

The impact of the added labeling and cost to train the new hires was greater than we expected in the second quarter. As a result, Military gross margins which are lower than our retail and retail segments were below historical levels. We expect Military gross margins to normalize during the second half of the year as we regain operating efficiencies and are able to leverage our expanded infrastructure on higher output.

And regarding future U.S. Military footwear contracts with what we know at this point in time, manufactures will be hard pressed to fulfill all of the demand well into 2017. We’re currently waiting to hear about awards for two current bids involving substantial pairs for which production will start as this year ends. So we're optimistic that we’ll be able to swing into next year with a well utilized factory with a fully trained and efficient workforce.

Looking ahead to the back half of the year, we believe the combination of our growing backlog and leaner channel inventories will drive a significant moderation in the core wholesale declines we experienced during the first six months of 2016.

At the same time, volumes in our military business will continue to increase which alone will improve efficiencies in our internal manufacturing operations we'll hope fuel better top and bottom line performance. And in light of the current retail environment, we are taking a harder look at our expense structure to identify potential savings in order to further protect profitability in the near term.

Longer term, we remain confident that our strategy of shifting more time in resources to support our growth prospects in the casual fashion segments of the footwear market will contribute to more consistent growth and greater shareholder value in the years ahead.

I’ll now turn the call over to Jim.

Jim McDonald

Thanks David. Net sales for the second quarter was $62.6 million compared to $68.6 million in the corresponding period a year ago. By segment, wholesale sales for the second quarter decreased 23% to $41.5 million compared to $53.9 million last year. Retail sales for the second quarter increased 2% to $10.4 million compared to $10.2 million a year ago. And Military segment sales increased 139% to $10.7 million versus $4.5 million for the same period in 2015.

Gross profit in the second quarter was $16.3 million at 26% of sales compared to $22.6 million or 33% of sales for the same period last year. The 700 basis points decrease was driven primarily by increased cost related to the ramp up in our production capabilities and a higher penetration of military sales which carry lower gross margins than our wholesale and retail segments.

Gross margin by segment were as follows: wholesale up 27.7%, retail up 44.5% and military 1.4%. Selling, general and administrative expenses were $18.8 million or 30.1% of sales for the second quarter of 2016 compared to $19.4 million or 28.3% in the year ago period. The $600,000 decrease in SG&A was primarily related to lower variable expenses associated with the decrease in wholesale sales.

Loss from operations was $2.5 million compared to income from operations of $3.3 million or 4.7% of net sales in the prior year period. For the second quarter interest expense was $142,000 compared to $176,000 last year. Net loss for the quarter was $1.8 million or $0.23 per diluted share compared to net income of $2 million or $0.26 per diluted share last year.

Turning to balance sheet, our funded debt at June 30, 2016 was $23.5 million, a decrease of $12.1 million or 34% from $35.6 million at June 30, 2015. Inventory at June 30, 2016 was $87.6 million compared to $86.5 million on the same day a year ago. The slight increase in inventory year-over-year was driven by the buildup of raw materials ahead of the ramp up in military footwork production and lower than expected wholesale sales in the second quarter. We feel very comfortable with the quality of our inventories.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Jon Komp from Robert W. Baird.

Jon Komp

Hi, thank you, hi guys. Wanted to start off may be with a couple of questions on the wholesale business and I’m just curious may be how you are thinking about the current state of the industry and kind of the inventory levels in the various segments. And maybe more specifically, I know you’ll start to cycle against what look like easier comparisons from last year.

So do you think at some point in the second-half you might get back to seeing year-over-year growth for the wholesale business?

David Sharp

Jon hi, I think the way we’re looking at it right now is that we can be flat with last year there are some optimistic things happening right now with our backlog. It's grown better than it had in Q2. But the part that we don’t know and the part that sort of we get in trouble with occasionally is the at once piece that has improved as we move through this past quarter. It’s looking pretty well for July, so I think overall we’re just looking at wholesale business and thinking that being flat with last year.

Jon Komp

And do you see a lot of variability quarter-to-quarter, I know obviously different drivers of the third quarter and fourth quarter, but how you are seeing the selling trends across the quarters?

David Sharp

I really don’t see any difference between third and fourth in terms of the trajectory of the business. I think that it will as we look at Q3 and Q4 of last year as you indicated they are much lower comps that we’re on sort of on pace to be flat with - as they were last year.

Jon Komp

Okay. And can you talk a little bit more just in terms of the backlog coverage for the back half if you could may be quantify it a little bit just how much the backlog covers for the period?

David Sharp

Currently it’s about 25% of the $100 million total cash that we did last year which is pretty strong for us at this time of the year. It’s particularly good it seems like our Western business is rebounding pretty nicely and but the Work business is just been a little tougher for us. And I think our competitors to as we read their transcripts.

Jon Komp

Okay, great. And then when you look at some challenges I know you characterized it David as been systemic and a lot of the pressures more short-term in nature. Is there anything when you look across the various segments that they might be more secular in some of the drivers and back in the business or do you really think it’s all more temporary factors?

David Sharp

We really do believe that it is temporary and it is systemic. We do - the Western talk is concerned a couple months ago that may be this is to it’s a – cyclical downturn in Western but given where we are right now is Western we’re actually feeling much better about that.

The other things I think the work and duty are definitely they are driven more by the economy and I think just this blue collar guy that we sell. So that’s the way we’re looking at it. Obviously another bright spot really is this commercial military business that we have. In Q2 we were up 40%. We were just looking at orders versus last year was one of the major players there and we just received their orders through December and they’re up 40%. So we are very hopeful that will continue to be strong for us.

Jon Komp

Great. Then may be shifting to the gross margin the first question I had I know that military business typically is about a 13% gross margin I think Jim I think you said it was close to 1% this quarter. So is it right just to look kind of at delta versus the normal level as a sense of some of the startup cost and efficiencies that you faced this quarter?

David Sharp

Yes, I think that’s right I think - on a normalize basis we’re in that 14% range we got orders to going forward but I think that - the difference between that and what we had in the second quarter was all related to the startup cost. They are still going to linger in third quarter here and I expect our margins to be up slightly from what they were in second quarter but not significantly. And then - as we move in the fourth quarter we should move into more normalized maybe not quite to the normalized but pretty close to that.

Jon Komp

Okay. So there is nothing in the structure the new contract that are inherently lower margin, it’s just will take some time on the startup cost side?

David Sharp

Yes, they are similar in margin to that. The reduction in margin is all related to the startup cost.

Jim McDonald

Yes, just little bit more color on that, back in December - we ended December last year with about 350 employees in Puerto Rico and today we have almost 1,100 without many more to onboard. So, and during that period we would hire four people and then lose one within a week or two but now we’re getting to more of a steady state.

Jon Komp

Okay, great. Maybe a last one from me, then just on the same topic gross margin but for the wholesale business just wanted to confirm I got it right. It was just under 28%, it does look quite a bit lower than usual so I am just wondering what the drivers were there and if you had any thoughts on this, the expectation going forward.

Jim McDonald

I think that from a wholesale business was also - we make the S2V boot the commercial military boots in the same factor as the contract military and we’ve had a big increase there, so we’ve had a lot of increase in people and manufacture those boots in those facilities in that facility too.

So that ramp up cost had an effect on the wholesale business also, as well as we had some off price sales that we did in the second quarter that had an effect on the margin but I think as we move forward, we’re looking at our on a year-over-year basis in third and fourth quarter our margins to be up slightly from what they were a year ago.

David Sharp

The source cost although the lower one we’ll start to ship some of those riding on boots in the third and fourth.

Jim McDonald

Right we’ve been sweeping, selling a lot out of inventory in the first half of the year and then but we’ve started to the stuff that we purchased this year is we’ve got some lower cost on that and we’ll start recognizing that in the back half of the year.

Jon Komp

Okay, great. I appreciate the color guys.

Operator

Our next question is from Mitch Kummetz from B. Riley.

Mitch Kummetz

Yes, thanks. So I just want to drill down a little bit on your wholesale outlook for the back half. So David I think you said flat sales. How would you think about that kind of across the wholesale business because it sounds like you probably expect Western to be up, it sounds like you expect maybe Hunting to be down and then working a little bit more of a wildcard or?

David Sharp

Yes, but I think we’re being conservative and right now it’s forecasted. So the down to flat and then commercial military the pieces in the wholesale segment obviously we expect that to be up considerably.

Mitch Kummetz

Okay. All right. So when you think about the work business and your outlook for down to flat, could you say like what percentage of back half work sales are out once versus backlog driven?

David Sharp

More like 80%.

Mitch Kummetz

Okay.

David Sharp

I mean the backlog that we have right now is little around Western and not so much around work. We do have a nice backlog on a couple of Georgia products but it’s not as extensive as these other categories.

Mitch Kummetz

I know you have some pretty easy comparisons against work in the back half particularly the fourth quarter right?

David Sharp

Right.

Mitch Kummetz

I mean what would happen and some of that I think was weather related right?

David Sharp

It was.

Mitch Kummetz

What could happen if the weather were more cooperative this year versus last, I mean to what extent give the at once nature of the business to what extent could you chase versus not chase and I guess it just depends on how you plan your inventory.

David Sharp

Well, we’ve taken a very conservative approach on our inventory, we have managed to – inventory is a little higher than it was at this point last year but all of that increase is in raw materials.

So we’re a little bit more conservative on the inventory. It would be much lower had we made our sales forecast in the first half but I still think there is enough there but there was a great demand in the fourth quarter that we’d be over the cash some of it.

Mitch Kummetz

Okay. And what are you seeing in the Western side that’s driving improvement there, is the oil patch getting better in some those markets where Western has been challenged?

David Sharp

I mean I think that the anxiety is perhaps a little less than they were. Retailers are starting to work through some of the goods. A lot of the Durango line is focused on the core market where folks who enjoy western lifestyle would always buy their products, they would always buy western boots and a lot of our brand caters to that western enthusiast that western call it user.

We’re hearing that higher price boots over 200 that are very fashion those products are very hard to move right now but we’ve never really been there with the Durango line, the Durango line is more 129 to 199 and most of it is a core market user.

Mitch Kummetz

Do you think there is a trade down happening?

David Sharp

Well I think some folks who are buying a lot of the fashion product they are not going to those stores anymore in search of that product because of the price, they can’t afford to buy it.

Mitch Kummetz

So what is your sales outlook for military and retail now for the back half of the year?

Jim McDonald

Military is going to be at about the same run rate that we had in the second quarter, about [indiscernible] almost $11 million probably in each of the third and fourth quarter right now.

Mitch Kummetz

Okay. How about retail.

Jim McDonald

About the same, it’s going to be up about the same amount as it was…

David Sharp

Flat to up slightly.

Mitch Kummetz

Okay. And Jim I think you said that in terms of the military gross margin in the third quarter that it would be a little bit better than the second quarter but still challenged.

Jim McDonald

Yes, it’s still challenged because we’re the cost of what we made – we made some of those in the second quarter that we’ll ship in the third quarter and we had those challenges in the second quarter. So we don’t think it’s going to, we’re going to have the staff what we train in July so moving around into the third quarter and then I think as things start to improve by fourth quarter. So I would say the Military margins will be up slightly and maybe 100 basis point or so in the third quarter and then closer to normalized levels in the fourth quarter as we start the initiatives.

Mitch Kummetz

Okay. It sounded like the Military, that the issues with Military on the production side it sounds like those kind of spilled over into wholesale is that not expected in the third quarter.

A - Jim McDonald

It’s expected to a much lesser extent because we’re out to production capability that we need on our commercial military boots that we make in the factory in Puerto Rico and the other that’s going to help the margin, there is two other things that are going to help the margin in the fourth quarter, in third quarter and fourth quarter is we’re selling now goods that we brought this year sourced goods that we’ve had a price reduction on so we’re selling out inventory in the first half.

We’re going to have a margin increase in those goods as we start to ship those in the third and the fourth quarter. And the thing we had some couple of big off price sales of discontinued product that we made low margins, pretty, very low margins on in the second quarter and we would anticipate having to have those in the third and fourth quarter.

David Sharp

And Mitch in my prepared statements I talked about a new style the C7 that we’ll be shipping soon and that boot is not very compliant, it’s produced in the DR where our margins are generally higher.

Mitch Kummetz

Okay. All right thanks guys.

Operator

Ladies and gentlemen we have reached the end of the question and answer session. I would like to turn the call back to management for closing remarks.

David Sharp

Okay, thank you. Thank you for joining us on the call today. We trust that we’re all working hard here in Nelsonville, Ohio to have a better quarter for Q3. Thank you.

Operator

This concludes today's conference for Rocky Brands. Thank you for your time and your participation. You may disconnect your lines at this time and have a good evening.

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